The aftermath of the financial crisis of 2007-08 saw a big reduction in bank lending, especially lending to small to medium sized businesses. While the last couple of years has seen banks relax lending restrictions slightly, of much more significance is the number of non-bank lenders that have entered the business loan market.
A business owner looking for funding to expand, or to cover a temporary cashflow shortage, now has more options than ever when it comes to applying for a business loan.
Who Can Apply for a Business Loan?
Business loans can be available to both established businesses and to startups. Applicants must be over 18 years of age and be the business owner (or a partner or director).
New companies will likely find that they have fewer options available to them than established businesses. They might also face higher interest rates and be required to offer more security to the lender, either in the form of a personal guarantee or by securing the loan against assets like a property.
No matter how established the business, in order to obtain an unsecured business loan potential borrowers will need to prove to lenders that a sufficient income stream exists to repay the loan. Borrowers will also almost always need good personal credit ratings.
As with all lending, the riskier the proposition appears to the lender the higher the offered interest rate is likely to be. The application process is the borrower's opportunity to prove to the lender that the loan makes sound financial sense and that the risk of defaulting on the loan (i.e. failing to repay) is very low.
What might Lenders ask for During the Application Process?
Depending on the lender and the particular criteria they've set for borrowers, a business loan applicant might be asked for a large number of different documents and information.
Banks especially will often want to gain an understanding of the financial health of an established business. Lenders will almost always want to see some evidence of sales and expenditure such as VAT returns and bank statements.
Your Business Loan and Cashflow Forecast
Of particular interest are your revenue projections as these can determine how realistic it is that you'll be able to repay the loan. The business plan is central to the application of a startup company - it will need to be impressive to secure funding.
Who is invested in the business and what is the size of their investment? Banks may be much more likely to lend to a business which already has a significant investment as they'll likely view this as a less risky proposition.
Purpose of the Loan
What's the loan going to be used for? This doesn't just help the lender check that the borrowing is sensible but also that the product chosen is fit for purpose. For example, a long term fixed rate loan might be sensible for a large capital expenditure but not to alleviate a temporary cashflow shortage.
Other Business Interests
Lenders might ask about any other business interests that you and your partners/fellow directors have. They want to know that you can commit enough time to running the business and ensuring that it earns enough money to repay the loan.
You might be asked to provide evidence of assets that can be used as security for the loan. These will need to be easy to value and to liquidate (e.g. property).
Banks might also insist on another form of security for the loan: a personal guarantee (or director's guarantee). This is a legal agreement which makes the directors responsible for repaying the loan in the event that the business defaults.
Where to Apply for a Business Loan
There are many options available when it comes to choosing a lender but they broadly fall into three main categories.
All the major high street banks offer business loans. The most common product on offer from banks is a fixed rate loan over a period of one to twenty five years. The advantage of these loans is that monthly or quarterly repayments remain constant over the life of the loan. Variable rate loans are also available. Most banks accept online applications though it is still possible to arrange an appointment at a branch for a more personal service.
Peer to Peer Lenders
A new entrant into the business loans marketplace, peer to peer lenders remove the need for a bank by connecting investors and borrowers directly. Companies like Zopa, Funding Circle and RateSetter offer fixed rate loans over periods of six months to five years. Interest rates are often lower than with banks, but peer to peer lenders generally won't lend money to startups. Peer to peer lenders mostly accept applications online.
Alternative Business Lenders
A number of new companies are offering business lending which differs to traditional fixed or variable rate loans.
A revolving credit facility, such as that on offer from Iwoca, is much like an overdraft facility, where interest is only paid on the part of the loan which is drawn down, only cheaper. Revenue finance, like that offered by Fleximize, is a loan repaid by a fixed percentage of future revenue.
Business Loan Risks and Alternatives
Taking out the wrong loan can have seriously negative effects on a business. Mismatching cashflow to loan repayments can lead to a downward spiral of borrowing and an ever increasing burden of interest payments which could eventually lead to a failed business.
In cases where owners or directors have pledged security it could also mean losing a home or personal bankruptcy.
It's therefore important to consider whether a loan is the right kind of funding and whether business needs wouldn't be better served by an alternative source such as:
- a business overdraft facility
- company credit cards
- invoice financing
- private equity/venture capital
- a government grant
Our Top Tips on Applying for a Business Loan
1. Contact Lenders Early
Gather a number of quotes before making any applications. Remember that the representative rates shown on lenders' websites aren't necessarily those you'll be offered. Quotes will be much more illustrative (just be sure to check that they won't leave marks against your credit history). It's also a good idea to form a relationship early, especially with banks, as they'll be able to guide you through the application process.
2. Get your Paperwork in Order
Make sure you have all the documentation you need before you submit any applications. Often an offer will only remain valid for 30 days and each application amends your credit history so don't get caught out.
3. Seek Independent Advice
If you're not sure whether a particular finance product is right for your business seek help from a qualified and independent financial professional. They'll be able to help you better forecast your borrowing requirements and choose the right kind of finance.