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What is a business loan?

A business loan is a loan you can take out to help your business grow, buy new equipment or cover periods of uneven income. There are lots of different lenders you can get a business loan from, and once you’ve been granted a loan, you then pay it back in instalments, with interest.

How do business loans work?

Understanding how a business loan works is important. When you apply for a business loan, you’ll have to tell the lender what it’s for.

In the same way as when you apply for a personal loan, you’ll need to show the lender that you can afford to repay the loan. 

You can choose how long you take it out for. You’ll usually pay it back over a period of one month to 25 years, depending on whether you go for a short, medium or long-term loan. 

The interest rate may be fixed for the duration of the loan, so the repayments would stay the same throughout, or variable, which means the rate could go up or down.

Types of business loans

Business loans broadly fall into two categories – unsecured and secured:

• Unsecured loans are when your business borrows money without using its assets as security. 

• Secured loans are when your business borrows money and uses an asset as security. If the repayments aren’t made, the lender can sell the asset to get their money back so interest rates are usually lower than for unsecured loans.

Other types of business loan, which will either be unsecured or secured, include:

• Peer-to-peer (P2P) loans – These are relatively new when it comes to business lending but they’re an option many people use when they need some extra cash. They work by a group of private investors lending their money to a small business. Their money is pooled to add up to the full amount you want to borrow. The lender earns interest on the loan and the small business pays it back, in the same way as if the loan was from a bank. This can be a good idea for businesses as they may have a better chance of securing funding than if they went to a bank but interest rates can be higher than for business loans. Although it can be a worthwhile way for lenders to invest their money, there are some risks involved. P2P lending isn’t covered by the Financial Services Compensation Scheme (FSCS). This means if the P2P lending platform goes bust, lenders may find it difficult to get their money back. Lenders can also lose their money if borrowers default on their loans. However, most P2P platforms have robust measures in place to protect lenders.

• Asset-based lending – This is a type of secured loan where the loan is secured on an asset your business owns, such as property or machinery. The amount you can borrow depends on the value of the assets.

• Invoice finance – This lets you borrow against the value of your unpaid invoices. There are two types – invoice factoring, where you borrow money worth a percentage of the value of your invoices and the lender collects the money directly from your customers to take its share, and invoice discounting, which is similar but you collect the payments then pay the lender for the service. 

• Revolving credit facility – This is flexible credit that gives you the option to withdraw money when you need it then pay it back and withdraw it again. You only pay interest on the amount you actually borrow.

• Bridging loan – This is a short-term secured loan designed to bridge the gap between needing funds and selling a property or other asset. The loan is repaid when the property or asset is sold. Interest rates are relatively high compared to longer-term loans. The smaller the amount you borrow, the quicker you’re likely to be able to pay it back. So you might borrow a small amount for a year or you might go for a larger amount and pay it back over a longer time period. Not all business loans are the same and you need to get one that’s right for your situation. Whether you’re a small business or a startup company, you’ll be able to find a loan that’s designed for you.

Can you use a personal loan to start a business?

Business loans are unsecured or secured loans specifically designed for businesses. However, it can be tricky to take out a business loan to start your company because most lenders want you to show two years of accounts when you apply.

If you don’t take out a business loan, it may be possible to use a personal loan to start a business. To find out more, read our guide on business loans vs personal loans: which is better for your business.

When you apply, the lender will ask you what you want the loan for, so it's worth checking before you apply for a personal loan if starting a business is a valid reason. Otherwise, you run the risk of being rejected.

There are also start-up business loans that are designed for new businesses.

Read more: How to get a loan to purchase an existing business: a step-by-step guide.

* Top results on money.co.uk in June 2023

Discover other ways to get finance for your business

What are the risks of using a personal loan for a business?

If you take out a personal loan for a business, it’ll be in your name. This means you’ll be personally responsible for paying it off if the business doesn’t make enough money to cover the repayments.

If you can’t cover them, you could damage your credit rating. This could affect your ability to get credit in the future.

Why your credit record matters

How much can I borrow with a business loan?

You can usually borrow £500 to £15 million when you get a business loan. But this will depend on your business’s situation and credit rating. It’ll also depend on what type of business loan you’re getting and how long you want the term to be.

Make sure you can afford the repayments and think about what you’d do if your financial circumstances changed.

Should I go for a longer-term business loan or shorter-term business loan?

How long you should repay a loan for will depend on your business and its finances. 

Longer-term loans usually have smaller monthly repayments and lower interest rates. But you’ll be paying them back for longer so you’ll pay more interest overall. It could also restrict your monthly cash flow.

It’s usually harder to get approval for a longer-term loan as there’s more risk your financial situation could change.

What information and documents will you need when you apply?

Lenders will need to know how much you want to borrow and what you want the money for. You’ll also need to provide a range of information to allow the lender to assess you for the loan.

Before you make your application, gather the documents you’ll need. Different lenders will require different documents. These might include:

• Business bank statements

• Financial accounts

• Business tax returns

• Personal tax returns

• Any other legal documents

• Proof of address and ID for the business owners

• Evidence of any other finance

• Details of assets that could be used as security for the loan

• A business plan

• Financial forecasts

• Balance sheets

Alternatives to business loans

If you don’t want to take out a business loan there are lots of other ways to get finance, including:

• Business credit cards – Like personal credit cards, these allow you to buy things and make payments up to a set limit. They can help you manage cashflow or pay for extra expenses. 

• Overdrafts – These are a flexible form of credit that give you a set amount you can withdraw beyond the money you have in your bank account. You can keep withdrawing the money then paying it back when you can to reduce the amount of interest you pay. 

• Equity crowdfunding – This is where a group or ‘crowd’ of people invest in a business – usually at an early stage – through an online platform in exchange for shares in the company or rewards, such as early delivery of the new product or service being developed by the business. 

• Merchant cash advance – This is for businesses that take debit and credit card payments from their customers. You borrow money in exchange for a percentage of the future card payments you take.

To find out more, read our guide on understanding business loans vs line of credit vs credit cards.