Covered in this guide...
What is a business loan?
A business loan is specifically intended for business purposes, as opposed to personal use. As with all loans, a business loan involves debt creation, which will then be repaid with added interest. The business loan is taken out against the business, not an individual person.
What are the types of business loans?
Although there are a few different arrangements business loans can take, they generally fall under two categories: Line of Credit and Term Loan.
Line of Credit
A business line of credit is like a personal line of credit, such as a credit card or overdraft. The business has access to a specific amount of funding but doesn’t make payments or incur interest until it the funds are tapped into.
Lines of credit are revolving, which means they can be drawn on repeatedly. A line of credit usually has a lower interest rate than a term loan. However, if you’re late with a payment or go over your borrowing limit, the interest rate can increase substantially.
Your business borrows a lump sum of money and pays it back over a specific time period (term). Unlike lines of credit, which may be renewed every one or two years, a term loan is fixed for the specified repayment period. Once your business has repaid the loan, you’ll need to reapply for a new loan if you want to redraw more funds.
Term loans can have different repayment periods, with an option of fixed or variable interest rates. Interest rates for term loans are usually higher than those on a Business Line of Credit.
Where can i get a business loan?
Banks have traditionally been the first port of call for people applying for business loans, especially for larger sums. You will increase your chances of a bank approving your business loan application if you can provide a thorough and convincing business plan, solid security and prove your business has a good track record.
- Competitive interest rates
- A range of business packages
- Banks often have slower application and approval process than other lenders.
- It can be difficult to get a large loan if your business is a start-up or has poor credit history.
The sole focus of finance companies is to lend money, rather than offer services such as business packages that banks do. Some finance companies specialise in certain industry sectors.
Often working faster than traditional banks, finance companies may accept online loan applications, which could mean a loan is approved more quickly. It might be easier to get a loan from a finance company, however their rates, fees and terms may not be as competitive as banks.
- Can be friendlier than banks towards start-up business or those with poor or limited credit history.
- Comparatively quick application and approval processes.
- Higher interest rates compared to banks.
- Some have shorter loan terms and more frequent repayments.
Peer-to-Peer (P2P) or crowd-lending platforms match borrowers with lenders via the P2P platform’s website. If the borrower is approved through the platform, the lender funds the loan at an agreed interest rate. The P2P platform oversees the application process and repayments.
- Competitive interest rates.
- Application and approval processes are online and relatively quick.
- Will offer loans to start-ups and those with a poor credit history.
- The loans are smaller than those offered by banks and finance companies and are usually short term.
- The loan application process happens in an online marketplace.
How much can I borrow
This depends somewhat on which lending institution you decide to borrow from. Banks, for example, typically lend a maximum of 50% of your business’s value. You may be able to get a larger loan by offering other assets as security, such as your home. In that case a bank could lend up to 80% of the value of the item being offered as security.
Your borrowing capacity will be determined on a case-by-case basis, taking into consideration several factors. It’s helpful to know the “Three Cs” which lenders consider when assessing whether to lend your business money and if so, how much.
What are the Three Cs of Lending?
The three Cs are really components of the fourth, most important C – your Credit Rating. The credit rating of a business may be in constant change, depending on how much debt the business accumulates and how reliably it pays its bills.
When making a decision about whether to lend money, a creditor will take the following areas into consideration:
Character refers to the borrower’s reputation. The lender will look at the credit history of the business owner to assess reliability and honesty. Considerations may include:
- Whether your business usually pays bills on time
- Whether or not you’ve used credit before
- How long you’ve been in business and any positions you held before starting the business
A lender will consider your business collateral to be:
- Accounts Receivable
- Real Estate
If your business were to fail, these assets can be sold to pay the loan.
Capacity, often considered as cash flow, denotes the ability of your business to repay debt. The lender will want to determine how much debt your business can handle. To evaluate the cash flow of your business, the lender may request:
- Tax returns
- Business plans and supporting financial information
- Personal financial statements for the business owner or guarantor
- Rent or lease records
Business Loan Summary
Pick the right lender
Commerical lenders tend to look after specific segments of the market. For example there are finance companies that specialise is start ups, growth phase, agriculture and equipment. Understand where you fit and approach the lenders who are setup to lend to businesses with your profile.
Understand the Three Cs
Character, collateral and capacity. Understand what the three Cs are, be prepared to answer questions about them and have documentation at the ready to back up your answers.
Prepare everything you’ll need for the Loan Application
When borrowing money for your business, you will be asked to complete a loan application. Having the application ready is an advantage, otherwise at least check to make sure you know the answers to the questions which are likely be asked on the application.
Include Personal Information
Your personal financial information may be required in order to secure a loan for your business. Therefore, make sure your personal financial records are in order and ready to be presented as part of your business loan application.