As a small business, finding the money to grow your business, cover your expenses or help with cash flow can be tricky. What can you do when you’re on a limited budget?
A potential solution is a business loan. By securing extra funding, you can bridge the gap between your goals and your income to uncover the potential of your small business idea. If your small business could benefit from a loan but you aren’t sure where to start, our guide on how to get a business loan is here to help. Take a look at the options available, how to prepare your application, and tips to boost your likelihood of securing a loan.
How to get a business loan as a small business?
As a merchant, securing a small business loan can drive growth and bring flexibility to your business plans. The application process can feel complex for first-time borrowers. To make it simpler, this guide outlines key steps for how to get a business loan, including:
Choosing the right loan for your business.
Preparing for the application process.
Improving your chances of application success.
Dealing with application rejections.
Looking at alternatives to loans.
Using a business loan to drive growth isn’t uncommon. Over the last 20 years, the government’s Start Up Loan Scheme has supported over 100,000 start-ups in the UK, delivering over £1 billion in small business loans.
What is a business loan?
A small business loan refers to a borrowed sum of money specifically for business activities. The loan is given by a third party (such as a bank or government-backed scheme) with a plan to repay the debt and associated interest over a set period of time. There are many different types of small business loans to choose from. One of the biggest decisions is whether to opt for a secured or unsecured loan. Using the comparison table below, we’ve explained the key differences between the two types of small business loans:
Secured loan | Unsecured loan |
Requires a collateral asset - such as a business premise or car - to provide the lender security if you can’t repay the debt. | Doesn’t require any collateral assets. |
Lower interest rates. | Higher interest rates and greater risks. |
Higher borrowing amounts. | You must prove eligibility with your business finances and credit score. |
Risk of asset loss for merchants. | Lower borrowing amounts. |
Risk of legal action to recover the debt. |
When you’re starting a business without many assets, it’s a great idea to check the requirements for an unsecured loan. This ensures you are aware of how to access essential funding and can grow your business from the ground up. It’s important to note, though, that unsecured loans are often harder to get approved for and carry higher interest rates. If you’d prefer a secure loan but don’t have the assets, you could also look into alternative forms of securing your debt. For example, some lenders will consider your unpaid invoices as collateral.
Why do small businesses take out a loan?
You can take out small business loans for a number of reasons, but what are some of the most common? Let’s take a look.
Starting a business
From learning how to start an online business to opening a brick-and-mortar establishment, creating a start-up requires investment. Even low-cost business ideas need initial funding. For example, if you’re starting a dog walking company, you need money to cover supplies like spare leads and toys, insurance, and advertising. You might also have travel expenses and need to fund dog first aid training and walking certifications. If you don’t have personal savings, a loan ensures you have the funding to cover your initial expenses. Once you start generating an income, you can reinvest your revenue back into your business and start paying off your loan.
Driving business growth
A loan can take existing small businesses to the next level, driving growth and boosting profits. Some of the growth strategies that loans are used for include:
Marketing.
Investing in new materials and equipment.
Hiring new staff.
Training employees to offer new services.
Expanding with a new business premises.
For example, if you’re a sole trader selling baked goods, you might discover that you could increase your profits with another baker on your team. This would allow you to bake more goods and reduce your production downtime. You take out a small business loan to cover the initial costs of payroll. Once you’ve hired your new baker, your revenue increases and you can cover their payroll and your monthly loan repayments.
Funding business opportunities
Business opportunities can come along that you can’t afford without generating immediate revenue. In these cases, a loan allows you to benefit from an opportunity as soon as the loan is in place.
Let’s say that you host music festivals. When an opportunity arises to organise an event, your loan allows you to buy crucial equipment. The high-quality set-up then increases ticket value and boosts demand, earning you a higher net profit.
Improving cash flow management
From how to price a product to dealing with taxes, managing small business finances can be difficult. A small business loan can help mitigate temporary financial problems. In particular, business loans are often used to improve cash flow management. When you have a gap between an incoming payment and an expense, a loan can help cover the difference for optimised operations management. This reduces downtime (periods in which production of goods or services stops), maintains your brand image and ensures you meet customer expectations. As long as you pay your loan back on time, it can also boost your financial history. Regular debt repayments that follow payment plans have a positive impact on credit scores, indicating to lenders that you can manage your debt.
Types of small business loans available in the UK
Learning how to apply for a business loan starts with choosing the right option for your small business. To understand more, let’s take a look at different loans in action:
Small business bank loans
Banks typically offer secured loans rather than unsecured loans. These require collateral and work in a similar way to personal loans but are intended for business use only. If you’re looking into how to get a loan to start a business or you need a larger sum of money, this is a great option to consider. Bank loans offer lower interest rates and often a long payback period of around 2-5 years. For example, if you run a local restaurant and you’re looking to open a second premises, a bank loan could be a suitable option. You can apply for a large loan to cover the expenses of your bigger project and arrange a payment plan to suit your needs. You can then use the money to:
Pay for the rent on your new premises.
Buy equipment for your second restaurant.
Pay for employees.
Advertise your second restaurant to the local community.
Government-backed loans
Government-backed loans are similar to bank loans. You receive a long-term loan with a set interest rate and a payment plan. However, government-backed loans tend to be unsecured, making them easier to apply for if you don’t have any assets to offer as collateral. If you’re looking into how to get a loan for a startup business, take a look at the government’s Start Up Loans. You can borrow anywhere between £500 - £25,000 and they do not necessarily require assets as collateral, making it an accessible option for the start of your small business journey. You can also find targeted loans through government-backed schemes. For example, if you’re a merchant in the West Midlands and you’re struggling to secure a traditional bank loan, look into ART Business Loans. These are designed for new and established small businesses operating in the West Midlands.
Keeping up with the latest government schemes is a smart way to learn more about the different options for your small business funding and how to qualify for a business loan, which we’ll be covering later in this guide. View the full list of government-backed loans to learn more about options available for different businesses. You can also look into government grants for small businesses. These are often advertised alongside government loans and provide an alternative funding option.
Short-term business loans
Short-term business loans are ideal for helping you deal with cash flow disruptions and keeping your small business accounting in order. For example, if you’re starting a side hustle selling homemade tables, you might experience pending payments. This occurs when money from a client has been paid but isn’t available yet.
Let’s say that a client has put in an order of £200 for a table. You spend this money on materials you need for two more tables. When you realise the client payment is pending, you notice that you no longer have enough in your bank account to cover your studio rent at the end of the month. A short-term loan provides a quick solution, depositing the money into your account instantly to cover your expenses. Once the pending payment clears, you can pay-off the loan without disrupting your business and fulfilling orders in time. Be warned, though, that short-term loans often come with high interest rates, so they’re not a solution for long-term borrowing.
Working capital loans
To understand working capital loans, we first have to ask what working capital is. Let’s take a quick look at a definition:
Working capital is the sum of money you have available to pay for your day-to-day operations, looking at all short-term financial obligations. |
To work out your small business working capital, you can follow the formula:
[Current assets] - [Current liabilities] = Working capital |
When working out how much it costs to start a business, you might see that you don’t have enough to cover your operational costs. In these cases, your working capital is negative and it’s time to look into a working capital loan. These temporary loans are frequently used to cover payroll and bills. They can also be used to take advantage of business opportunities when you don’t have working capital to cover the costs. Let’s say, for example, that you sell kombucha at a local market. When a customer puts in a large order to cater for a well-attended event, you don’t have the working capital to accept it, but you don’t want to turn down a substantial sale, either. Rather than declining the order, you could take out a working capital loan to help cover costs. Once the customer pays for the kombucha, you can repay the loan and still retain a net profit and a boost to your brand awareness.
Merchant cash advance
When it comes to small business accounting, merchant cash advance (MCA) loans are one of the lesser-known methods for managing your cash flow. These loans provide short-term funding for businesses that accept debit and credit card payments. MCA loans are typically unsecured, making them easier for small businesses without assets to apply for. After approval, you receive your payment, a repayment period (typically short-term) and an interest rate. Where this loan is different from other options is in how it’s repaid. Rather than transferring money to your lender, you instead pay a percentage of any fees taken through your card reader. Often, this is around 10%, though rates will vary depending on your loan. This is a great option for adding flexibility to your repayments, allowing you to automatically pay off more of your loan during more profitable periods and scale back if sales decline.
Small business loans pros and cons
Weighing up the advantages and disadvantages can help you determine whether your business will benefit from a loan. To help guide your next steps, we’ve created a comparison chart that looks at both sides.
Advantages of small business loans | Disadvantages of small business loans |
Can improve cash flow management. | A lengthy application process without guarantee of approval. |
Helps small businesses find the working capital to take on profitable projects. | You often need financial history and documentation to be approved, which can be difficult for startups. |
Can speed up business growth. | Secured loans carry the risk of losing your assets. |
You remain in full control of your business. | Too much debt can lead to business bankruptcy. |
Can boost your business credit score. | Interest rates can increase over time, leading to more expensive debt. |
Loans often have more favourable terms than credit cards. |
If you’re not certain whether a loan is the right option for your small business, a financial advisor can help. They’ll look at your financial needs, match them to the correct funding and even help with your application.
How do I prepare to apply for a business loan?
Whether you’re looking into solutions for how to start a business with no money or you want to fund an upcoming project, the more you prepare the likelier you’ll be to secure a loan. To help you secure loan approval, we’re going to look further into:
What lenders look for in a loan application.
What the application process involves.
How long it takes to get a business loan.
You can also make the application process simpler by:
Writing a business plan that demonstrates the reason for the loan.
Knowing how much money you need to borrow.
Knowing how much you can pay off over a period of time.
Clarifying the type of small business loan you’re looking for.
Checking your eligibility.
Preparing your documents.
How to get a small business loan?
When it comes to how to get a loan for a small business, understanding what to expect will help you write a strong application. Building on our preparation tips above, let’s take a look at how to get a business loan in the UK in more detail.
Where to get a business loan
For merchants wondering where to get a business loan, you can apply with banks or look into government loans, including government-backed schemes launched by third-parties. You can also consider independent money lenders. These are typically used for short-term loans, but they can also offer long-term financial solutions. Before working with an independent money lender, ensure they’re fully authorised under The Financial Conduct Authority. Always read the terms and conditions of your loan and if in doubt speak to a financial advisor.
How to choose the right loan for your small business
When looking at how to get a business loan in the UK, keep in mind:
How much you can borrow.
Interest rates.
Payback periods.
As a small business owner, it’s important to know how much a loan will cost you. Let’s say, for example, that you own a restaurant in need of a £25,000 loan. A typical bank loan would have an interest rate of 8.9% APR. Let’s say that you secure a fixed interest rate and a 48-month repayment plan. You’d be required to pay:
Monthly payment: £618.80.
Repayment period: 3 years.
Total amount repaid with interest: £29,606.40.
Increase your repayment plan to 60 months and your monthly payments reduce to £513.52, but your total amount to be repaid with interest increases to £30,811. To make your loan worthwhile, you’d need to see a return of around £5,000 on your investment. If you’re using the loan to buy a second premises for your restaurant, make sure to calculate whether the expected returns would exceed the £5,000 interest payment and any other costs, like additional employees and equipment. If it’s not profitable, consider looking at:
A different option for funding (such as a small business grant).
A shorter repayment plan to reduce interest accumulated.
What eligibility criteria you should be aware of
Lenders use eligibility criteria to reduce the risk of lending money. As a small business, eligibility factors you should be aware of before applying include:
Legal requirements
Make sure you’ve followed all the legal requirements when starting a small business to increase your chances of securing a loan.
Business plans
Many lenders will want to check that your business plan is viable before approving a loan.
Credit score
A good credit score (for business scores this would be over 50, but preferably upwards of 70-80) is crucial for an easy application and unsecured loans.
Debt-to-income
Your debt-to-income ratio tells lenders how well you manage existing debt.
Financial statements
Your lender will review financial statements (including income statements and expense reports) to work out the financial health of your small business.
Business performance
Tying into the financial statements, lenders may want to look deeper into your business performance. This can include profit and loss records as well as revenue growth over time.
You might also be required to pass eligibility checks as a merchant, including proving personal financial stability and a good credit score. Remember, though, that the criteria can change depending on your lender. Be sure to check specific eligibility requirements with your bank, government-backed scheme or independent lender.
What documents you’ll need when you apply
Lenders can ask to see documents (both business and personal) to learn more about your application. This includes:
Proof of identity.
Proof of address.
Business plan.
Sales forecasts.
Cash flow forecasts.
Profit and loss and balance sheets.
Bank statements.
Business registration documents.
Before applying, speed up the process by locating these documents.
How much can you borrow?
Small business loans vary in maximum amounts, with some lenders offering up to £500,000. As a small merchant, though, it’s more common to take out loans of up to £25,000 for more manageable repayment plans. To boost your chances of approval, work out how much you can afford to borrow. Look at your monthly cash flow forecast to gauge your maximum repayments and leave room for fluctuations in your income over time.
Speak to professionals
If you’re wondering how to get a business loan in the UK, speak to a professional for tailored advice. A financial advisor, government employee or your bank can tell you more about what loans you’re eligible for and how best to apply. Before your meeting, make sure you’re prepared with a full breakdown of your current financial health. This includes your business income and expenses along with any existing debt you need to disclose. The more your advisor knows about your business finances, the better they’ll be able to help with your loan application.
Can you get a business loan with a bad credit score?
Before applying for a business loan, it’s smart to check your business credit score. This is a number given to show lenders a quick overview of your financial history, including if you’ve regularly paid off debt repayments in the past.
A bad business credit score tends to be anything less than 380. A bad business credit score is anything less than 50. The worse your credit score is, the less likely your loan application will be approved.
How to get a business loan with bad credit
Fortunately, there are some lenders who accept merchants with bad credit scores for loans. They tend to give out short-term loans with high interest rates. You might be able to speak with your lender about a secured loan. By offering assets as collateral, a bank or independent lender may be willing to overlook your credit score. You could also look into options for a financial guarantor. This is an individual with a good credit score who’s willing to put their name down on your loan and assume responsibility for your debt if you can’t pay it.
Building a business credit score
One of the reasons to separate business and personal finances is your credit score. By having separate accounts, you won’t be affected by your business credit score and vice versa. For start-ups, your business account will have a low credit score if you don’t have any financial history. To improve your score and increase your likelihood of being approved for a loan, follow these tips:
Stay within the overdraft limit of your business current account.
Charge small business expenses to your business credit card and pay them off on time.
Set up direct debits to pay your bills on time.
What happens if my loan application is rejected?
If you need a loan to start an online business, manage cash flow, or fund an exciting new project, it’s always disheartening when your application is rejected. If this happens to you, don’t give up on your small business idea. Instead, learn from the process and follow these steps to improve your chances of finding funding.
Identify the reason for rejection
Loan rejections can happen for several reasons, including:
A low credit score.
Lack of trading history.
Not enough value in your business plan.
Not enough assets for collateral.
Errors in your loan application.
By identifying the cause of your rejection, you can start taking action to make approval more likely. For example, if a low credit score is to blame, speak to a professional about how you can build a more positive credit history.
Rework your application
When applications are rejected, it could be because the correct forecasts and documents weren’t included. Meet with a member of your bank or a financial advisor to work on any weak areas to improve your likelihood of acceptance.
Try the bank referral scheme
One rejection isn’t the end of your loan journey. Rather than giving up, look to other lenders that might be more suitable for your needs using the Bank Referral Scheme. This is a platform that matches rejected loan applications to different lenders. Its aim is to stop a high-street bank rejection from putting merchants off of future loan applications by referring them to alternative funding methods.
Look into a Start Up Loan
You could also look into the government’s Start Up Loan. A Start Up Loan is designed to fund the initial cost of starting and developing a business, making it a potential choice if you’re looking into how to get a loan for a small business idea.
The Start Up Loan is available for anyone who has or plans to, start a business that has been trading for 36 months or less.
Unlike a business loan, a Start Up Loan is an unsecured personal loan. You must be:
At least 18 years old to apply.
Be a UK resident.
Need to pass a credit check.
You can repay the loan over a period of 1 to 5 years. There’s no application fee and no early repayment fee.
4 alternatives to traditional business loans
When you can’t secure a traditional business loan, it’s time to look at alternatives. Luckily, there are plenty of options out there to fund your business idea, and we’ve taken a look at some of the best for small merchants.
Small business grants
Small business grants don’t have to be repaid, making this a major financial win for your small business. To give you an example of what you can expect from grants, here are some popular choices in the UK:
The Prince’s Trust
Grants designed for young people between 16 and 30 who are looking for training and support while starting a business.
Innovate UK Business Growth
For merchants with innovative products or services, you might be eligible for funding through Innovate.
Power to Change
Seek funding for your community business that’s designed to bring positive change in your local area.
WRAP Grants
Increase the use of recycled materials in your next project with funding from government-backed WRAP.
Crowdfunding
Small business crowdfunding platforms have become a popular way for merchants to fund new ideas. The process is simple:
You outline your business idea and highlight your unique selling point (USP) on a crowdfunding platform.
Interested funders invest in your idea to help bring your business to life.
In return, you offer them equity or a reward for their investment
Once you reach your goal, you can use the money to fund your business.
Peer-to-peer lending
When you’ve exhausted solutions for how to get a business loan from a bank, peer-to-peer (P2P) lending also offers an alternative. P2P platforms match small businesses with individual, private investors. Without eligibility constraints and traditional terms and conditions, you might find it easier to secure a loan.
Business credit cards
Credit cards are another method of borrowing money for your business. Credit cards don’t come with the same fixed payment plans, either, making them more flexible for your small business.
Credit cards often come with a higher interest rate than loans. They also carry minimum monthly payments, which will increase as you spend. If you can’t make these payments, you’ll incur additional fees and see your credit score drop.
Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.
How to get a business loan FAQs
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