Is it worth getting a loan to start your business?

What is a business loan?

Business loans are lump sum payments made by banks and other lenders. They must be repaid – along with any interest or fees – according to the terms set out in the loan agreement.

The business loans you can get from banks and other traditional lenders fall into two categories:

Unsecured business loans: These work like personal loans – you borrow a sum of money, say £10,000, then repay that amount plus interest (and often fees) in regular instalments within an agreed timeframe.

Secured business loans: These loans work in a similar way but you have to offer up an asset, such as property, as collateral. The lender can seize this asset if you default on the loan.

But if you want to start a business – or are looking to develop a business that has been trading for under three years – you might want to look into a start-up loan, which could be a secured or unsecured loan.

How much does a business loan cost?

The interest rates and fees charged on business loans depend on various factors, including how much you need to borrow, how quickly you can afford to repay the loan, and what type of loan you take out.

Commercial start-up loans, for example, tend to come with higher interest rates and require you to provide either a personal guarantee – meaning you will be responsible for the loan repayments if the company is unable to pay – or an asset the lender can repossess should you fail to keep up with the repayment schedule.

As an example, one lender advertising start-up loans at the time of writing (January 2024) was offering loans of between £6,000 and £10 million over one to six years at interest rates ranging from 10% to 45%. This was a secured loan, requiring either a residential or business property as collateral.

However, entrepreneurs in need of a cash injection to start a new business can also apply for funding via the government’s Start Up Loan scheme, which offers loans of up to £25,000 over one to five years at a fixed interest rate of 6%.

Advantages of this scheme, run by the not-for-profit British Business Bank, include no loan fees to worry about, and access to a free mentoring support programme aimed at maximising borrowers’ chances of success.

As with other types of business finance, however, you’ll need to meet certain requirements to qualify.

When should you get a business loan?

As an entrepreneur, you need to show lenders that you can meet their lending requirements. So, before applying for a business start-up loan, you need a detailed business plan and a cash flow forecast that demonstrates you will be bringing in the money required to meet the loan repayments. This is true of all business loans, wherever they are from. 

If you want to benefit from the government Start Up Loan scheme, you must also apply within the first three years of trading. 

After this point, you should have the financial history required to apply for a standard business loan instead.

What are the alternatives to a start-up loan?

Start-up loans are a popular way for new businesses to raise funds, but they are far from the only option. 

If you need to buy a vehicle to make deliveries, for example, you may be better off taking out business vehicle finance. 

And if you can meet the criteria for a government grant, most of which are linked to a particular sector or geographical area, you can benefit from a cash injection that you don’t need to pay back.

Other ways to raise money include:

• Friends and family: If your relatives or friends have spare cash, you can ask them to either invest in your business or lend you some money at a preferential interest rate

• Crowdfunding: You offer investors a small stake in your business in return for a sum of money. This can be arranged via a crowdfunding website

• Peer-to-peer loans: Taking out a P2P loan involves borrowing money off individuals via an online platform. The interest rate you pay will depend on the perceived level of risk attached to your offer

• Angel investors: These are high-net-worth individuals, like the ‘dragons’ in the TV series Dragon’s Den, who provide seed funding to new businesses in return for a stake in the company

• Business credit cards: These work like personal credit cards, but are used by businesses. As a start-up founder, your chances of getting one will usually depend on your personal credit score

Are bank loans a good idea?

Bank loans are just one way to raise funds to start a business. So, let’s take a closer look at the pros and cons of financing your business ambitions in this way.

Advantages and disadvantages of business loans

Pros:

• You get the money you need to turn your business idea into a reality, sometimes in a matter of weeks or even days

• You can use the money for whatever you like, which may not be the case with a grant or an investment

• You can set the amount and – to some extent – the repayment terms according to your needs

• You do not have to give up a stake in your business to take out a business loan; in other words, you retain total control of your company

Cons:

• You have to repay the full amount borrowed, plus interest and possibly fees

• You will need to meet the lending requirements to qualify

• If you choose a secured loan, the assets concerned can be repossessed if you fail to meet the repayment terms

• If you offer a personal guarantee and the business can’t repay the loan, you’ll have to use your own money instead – even if the business has gone bust