When cash is needed to finance investment, banks offer many more options to small businesses than to individuals. In the UK, small business loans can work very differently depending on the exact type of loan: short term business loans, startup business loans, secured or unsecured business loans... all have many variations depending on the needs of the business customer and available collaterals.
The downside of this abundance of solutions is that they may seem very technical to understand, let alone choose from, for any professional not familiar with modern finance.
Therefore, this article is aimed at:
- Explaining how several types of small business loans work, as well as the disadvantages and advantages of these small business loans,
- Indicating how to compare business loans, their terms and their rates
Types of small business loans and their advantages
In the UK, many business loan types are made available by business banks, making business financing relatively easy. However, in order to choose the best business loan for one’s needs, it’s important to at least have an idea of how the various types of loans currently on offer work. Secured business loans, unsecured business loans, asset-based lending and equipment loans are the most common types of loans offered to businesses.
Secured business loans VS unsecured business loans
Secured business loans and unsecured business loans are the two main broad categories of business loans.
Secured business loans are certainly the most widely available type of business loans, as they are the least risky for banks. They are called “secured” because they are backed or “hedged” by a “security” from the borrowing company or business, which works just like a collateral.
Many kinds of securities can be used to hedge secured business loans, defining the exact type of loan: buildings, material and immaterial assets like equipment, patents, shares, stock options or even redeemables such as contracts and invoices. Assets are valued by banks, with a discount rate applied, so as to decide how much money can be borrowed and at what cost (the interest rate or “APR”). In case repayments can’t be made, the assets are simply transferred to the lending banks.
Advantages of this kind of loans are that they may allow very large amounts of money to be borrowed, at low interest rates, and that they are relatively easily granted – as long as credible assets can be found. But they’re not very flexible, take a long time to set up, and of course, the borrower may just lose the assets when repayments can’t be made.
In the UK, unsecured business loans are also available. These loans are not hedged by any company asset, and are therefore less risky for the business customer. However, interest rates are far higher than with secured loans, and it may take months, and a lot of persuasion, to put the framework in place with the bank.
Asset-based lending and invoice financing
Asset-based lending is therefore more or less synonymous with secured business loan.
Quickly-moving assets are often used to get quick cash from the bank, based on quickly materialising assets such as invoices sent to a regular customer of the borrower.
With asset-based lending, the invoice is just used as collateral, and it’s up to the invoicing company to get the invoiced customer to pay the bill. With factoring, the invoice is simply purchased by the bank, as well as the business-customer relationship that goes with the invoice.
The biggest advantage of asset-based lending is that it represents quick, easy cash, sometimes worth up to 90% of the value of hedged invoices. The biggest problem is that this business finance product is reserved to large corporations with turnover in the 6-digit zone and stable, solvent customers.
Merchant cash advance
A merchant cash advance or MCA is a type of business loan for B2C merchants, either online or in-shop.
Rather than resting on the promise of monthly repayments, the lender directly receives a cut of daily credit card sales made in the shop or e-shop of the borrower to gain back the cash advance credited to this merchant.
The plus side of this method is that “repayments” are only made when money actually comes tickling in, and as a direct proportion of these earned funds.
The downside is that interest rates are punishingly high, sometimes as high as 100%!
Equipment loans
Equipment loans are a type of loan with precise, limited scope, as it’s only supposed to pay for the purchase or lease of business equipment, hardware, software, or even vehicles.
It’s a very relevant kind of loan for new businesses as it isn’t based on any pre-existing company asset but on the value of the equipment purchased with the loan itself. Other advantages include relatively decent APRs (5-25%).
Disadvantages obviously include the fact that the equipment purchased is put at risk of being taken away in case repayments can’t be honoured.
How to compare business loans
Key aspects related to the terms of the loan contract need to be carefully reviewed before deciding on any business finance option. Interest rates, and total cost of financing are of course part of these factors: a precise strategy to collect quotes is therefore a real plus to compare business loans.
Compare business loan terms
Business loan terms naturally need to be carefully reviewed, but there’s so much to read that it may be difficult to know what to focus on in order to compare business loans from different financial organisations.
Some key aspects of the contract are however more important than others:
- Securities used to hedge the loan need to be very precisely defined, as need to be the circumstances which would trigger the transfer of these securities to the bank.
- Interest rates seldom represent the total cost of financing – mandatory fees like setup fees, monthly fees or insurance fees usually apply, and potential fees like prepayment penalty can also apply. Also, the loan term or duration of the contract has a strong effect on total financing costs. It is therefore recommended to calculate the annualised total costs of the plans in order to better compare business loan costs.
- Flexibility may be an important factor for some business borrowers, so these borrowers will be especially careful when reviewing all the amendment options to the “normal” course of the loan,
- “Backup” solutions are part of this concern for flexibility: many banks may offer overdraft facilities as an addition to their loans, which can come in really handy when one repayment can’t be made on time,
- Restrictions on the use of the loaned funds can also apply,
- Finally, some conditions may directly and significantly affect daily business, by forbidding the borrower to offer credit to its own customers during the loan term.
Compare business loan rates
All that has been mentioned above regarding the true cost of a loan, after compiling interest rate and all possible fees related to the loan, helps understand why it’s essential to get as many quotes as possible, as detailed as possible, from as many lenders as possible in order to compare business loans.
Also, it must be known that banks will always ask prospective borrowers to submit a whole lot of documents to back their demands. So in fact, it’s always good to have this material ready even before banks ask for it, and always better to give them more information than what they ask for.
Add the fact that most negotiations for a business loan with a single bank may take months, and you’ll understand that the whole process of quote collecting can be extremely time-consuming and frustrating.
Fortunately, some online tools make it all much easier. For instance, Companeo makes it much simpler to compare business loans, by bringing quotes from multiple top providers directly to your e-mail inbox after just a few minutes spent on companeo.co.uk. And the best thing is that Companeo is a totally free, no-strings-attached solution.