How Small Business Loans Work

Business meeting

Like a personal loan, a business loan involves going to the bank and asking to borrow some money – the difference here is that you’re taking the money for specific business use, and therefore have to be able to prove to the bank that your idea for a new company has a chance of working out.

Most of us don’t have the spare cash to start up a business without any financial help, but the process can be confusing if you’re just starting out.

Here’s a beginner’s guide, explaining how business loans work and what you should do if you’re thinking of getting one.

What are business loans for?

Group of diverse businesspeople smiling while discussing paperwork together during a meeting around a table in a modern office

Generally, a business loan can help you with the costs of starting (or expanding) your company. It’s a good way for businesses to deal with the cashflow conundrum that comes from needing to spend money before you can make money. Beyond that, it’s down to you to work out the money should be best spent. It might include:

  • Investing in stock
  • Moving into new offices
  • Hiring more employees
  • Repay debts
  • Buy more equipment, or upgrade

How much money you can get will depend on your needs. It varies wildly, from small sums of just a few hundred pounds right up to hundreds of thousands. The important things is to spend time considering exactly what you need money for and how you will pay it back.

How is a business loan different to an investment?

With an investment, you’ll need to give the investor shares in your company in return for their money. This means that they own part of your business, and that they’ll get a return on their money if you’re able to grow the company successfully. With a bank loan, you need to pay the money back in a fixed time frame at the rate of interest agreed. Assuming your business does well, you’ll probably end up paying back less – but if the company starts to lose money, you’ll still be on the hook for the loan.

The other key difference is the relationship that you have with a bank vs an investor. The bank has no claim to your business other than the money they’ve lent you. This means they won’t tell you what to do or how to do it. An investor, on the other hand, may be able to give you expert help and guidance.

How do I start the process?

Most businesses can apply for a loan, but you’re only likely to be approved if you meet the bank’s criteria. This might include things such as being VAT registered, having a minimum turnover or having been running for a certain number of years. Different providers offer different types of loan, and some specialise in helping companies who are just setting out: their criteria may be more flexible.

Then you need to look at different business loans and consider which one is likely to suit your needs. If you’re not sure where to start then a comparison site like MoneySuperMarket may help you consider the options. Once you’ve found a loan, it’s time to have a good read through the providers’ criteria and getting all your documentation together. The application may include an in-person interview, so it pays to be prepared!  

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