How Do Business Loans Work in the UK? A Practical Guide

In the past three years, nearly 30% of UK SMEs sought external financing.

However, rising inflation, fluctuating interest rates, and ongoing geopolitical tensions have left many hesitant to take the plunge into securing a business loan. Despite these challenges, business loans remain a vital financial resource for maintaining cash flow, funding growth, and acquiring essential assets.

Business loans are designed to provide funding for essential business needs like expanding, purchasing equipment, or managing daily expenses. Unlike personal loans, business loans offer larger amounts and longer repayment terms, making them an ideal choice for companies aiming for rapid growth. This practical guide will explore how business loans work in the UK and highlight their potential to provide flexible solutions in today's evolving financial landscape.

Understanding Business Loans: A Key Resource for Growth and Stability 

A business loan is a financial product that helps companies fund essential activities like driving growth, purchasing equipment,  or cash flow needs. Unlike personal loans, business loans offer larger amounts—often in the hundreds of thousands—and have flexible repayment terms, from a few months to over 25 years.

These loans are tailored to business needs, with lenders assessing financial health, turnover, and documentation like business plans. In contrast, personal loans primarily hinge on individual credit scores and tend to be simpler to obtain but come with smaller amounts and fewer business-oriented advantages.

Business loans can also come with additional perks, such as support services or tax benefits. All these benefits cumulatively make business loans a major resource for any growing business.

Types of Business Loans in the UK

Business loans come in various forms, each designed to meet the unique needs of SMEs. Here’s a breakdown of the most common options available:

‍

1. Secured Business Loans

Secured business loans use assets like property or equipment as collateral, allowing businesses to access larger amounts at lower interest rates. They generally have favourable terms, with repayment periods extending up to 25 years. However, while the longer repayment terms are appealing, they come with the risk of losing assets if repayments aren't met.

2. Unsecured Business Loans

Unsecured business loans don’t require collateral, which makes them accessible to businesses without significant assets. Instead, loan approval is based on the financial health, creditworthiness, and turnover of the company. 

While these loans pose a greater risk to lenders, they often come with higher interest rates and shorter repayment terms, usually up to five years. Despite the higher cost, unsecured loans are an ideal option for businesses looking for fast access to funds without risking their assets.

3. Short-Term Business Loans

Ideal for businesses needing quick cash to cover immediate expenses, short-term business loans offer fast funding solutions. Repayment periods range from a few months to two years, with higher interest rates reflecting the shorter loan term. While they may be more expensive, these loans provide the flexibility necessary for businesses facing urgent financial needs.

4. Working Capital Loans

Working capital loans help businesses maintain daily operations during periods of low cash flow, making them especially useful for those with seasonal sales fluctuations. These loans provide the liquidity needed to cover immediate expenses such as payroll, inventory, or rent. 

However, since these loans are repaid from future revenues, businesses must be confident in their ability to generate sufficient cash flow.

5. Invoice Financing

Businesses can unlock the cash tied up in unpaid invoices by borrowing against their value through invoice financing. Lenders usually advance between 70% and 90% of the invoice value upfront, and the business repays the loan when the customer settles the invoice. 

This option lets businesses manage cash flow without taking on additional debt, but the associated fees mean they’ll receive less than the total invoice value.

6. Merchant Cash Advance (MCA)

Merchant Cash Advances (MCAs) provide businesses with a lump sum upfront in exchange for a percentage of future credit or debit card sales. This repayment model is flexible and adjusts to the business’s daily card transactions. 

While MCAs are convenient for businesses with unpredictable cash flow, they also have higher costs and interest rates than traditional loans, which can make them a more expensive option in the long run.

7. Asset Finance

Through asset finance, businesses can acquire essential equipment, vehicles, or technology without upfront payment. The asset itself serves as collateral, reducing the lender's risk. Payments are spread over time, and businesses can maintain cash flow while securing necessary assets. 

However, failure to meet payment obligations can lead to the repossession of the financed asset, so it’s important to ensure affordability before committing.

8. Government-Backed Loans

Government-backed loans, such as those under the British Business Bank’s schemes, provide favourable interest rates and more flexible terms compared to traditional loans. They are often aimed at supporting new, growing, or innovative businesses. 

Many government-backed loans also provide extra resources like mentoring or business advice. However, eligibility criteria can be strict, and not all businesses may qualify.

‍

How Business Loans Work in the UK

Securing a business loan in the UK follows a structured process that can vary between lenders. Whether you opt for a traditional high-street bank or an innovative online platform, here’s a breakdown of what to expect:

Application Process

By thoroughly preparing each step, you increase your chances of approval while positioning your business to secure the best possible loan terms.

1. Research Lenders

The first step is exploring different lenders, from established high-street banks to alternative online platforms. Each lender offers unique terms, interest rates, and conditions, so it’s crucial to compare these carefully.

• Traditional Banks: Typically offer competitive rates but may impose stricter requirements and longer approval times. 
• Alternative Online Lenders: Often provide faster approvals but may come with higher interest rates. ‍
• Peer-to-Peer (P2P) Lending: Connects businesses directly with individual investors, often resulting in more flexible terms.

2. Prepare Documentation

To determine eligibility, lenders will request specific documents, including:

• Business Plan: This is the backbone of your application, explaining how the loan will be used and repaid, with detailed financial forecasts and growth strategies.
• Financial Statements: Lenders require profit & loss accounts, balance sheets, and cash flow forecasts for the past two years. Startups can submit financial projections instead.
• Credit Scores: Both your personal and business credit scores will be evaluated. Higher scores often result in better loan terms.
• Business Registration and Address Proof: This verifies your company's legal status through documents like your certificate of incorporation or proof of registration from HMRC.

3. Submit the Application

Once all documents are ready, submit your application. The submission process differs between lenders. 

Online lenders, for example, tend to have more streamlined systems and can sometimes provide approval within 24 hours. 

On the other hand, traditional banks may have a more thorough review process, often requiring additional information or follow-up questions after the initial submission. 

The thoroughness of this process, while slower, can work to your advantage if you are seeking larger loan amounts with better interest rates.

Loan Approval and Disbursement

Once you submit your loan application, lenders assess your business’s financial health, credit, and cash flow. This evaluation process usually differs between traditional banks and alternative lenders.

Traditional Lenders: Rigorous Evaluation for Better Terms

Traditional lenders like high street banks have a more detailed approval process. They’ll typically request comprehensive financial records, such as: 

• Profit and loss accounts
• Balance sheets
• Bank statements 

If you're applying for a secured loan, they may also require collateral appraisals. While time-consuming, this rigorous approach provides businesses with better interest rates and longer repayment terms, especially for secured loans.

Alternative Lenders: Speed and Flexibility

Alternative lenders, which include online and peer-to-peer platforms, offer a more streamlined process. Using technology-driven approval systems, they often approve loans within 24 to 48 hours, making them a faster option. 

These lenders rely on more flexible criteria and are an appealing choice for businesses with lower credit scores or limited collateral. Since many alternative lenders operate fully online, the documentation process is simpler, and approvals are granted quickly, even for businesses that may not meet the stringent requirements of traditional lenders.

Loan Disbursement Options

Once the loan is approved, disbursement methods vary. 

• Lump-Sum Disbursements: Traditional loans are usually provided as a lump sum, ideal for large, one-time expenses like equipment purchases or expansion projects.
• Revolving Lines of Credit: This option offers more flexibility, allowing businesses to draw funds as needed. It’s suitable for ongoing operational expenses or cash flow management.

Repayment Terms: What to Expect

Repayment terms are agreed upon upfront:

• Secured Loans: Often have extended repayment terms, sometimes up to 25 years.‍
• Unsecured or Short-Term Loans: Typically come with shorter repayment schedules and higher monthly payments due to increased interest rates.

Why not streamline this entire process? With FundOnion, you get a one-stop solution to easily compare lenders, loan types, terms, and interest rates and find the most suitable funding option for your specific needs. All that within just 90 seconds!

Interest Rates and Fees

Business loans in the UK have varying interest rates and fees, depending on factors like loan type, credit profile, and the lender’s terms. Understanding these variables can help you secure the best possible loan.

Loan Type

Secured Loans: These loans, backed by collateral like property or equipment, offer lower interest rates, typically ranging from 4% to 12-15%, depending on the loan size and value of collateral. They’re more accessible to businesses with valuable assets.

Unsecured Loans: Since no collateral is required, unsecured loans come with higher interest rates, starting at around 6% and often exceeding 20%. Lenders assume more risk, making these loans costlier, especially for businesses with limited credit history.

Factors Influencing Interest Rates

• Creditworthiness: Businesses with stronger credit scores secure lower rates. Companies with weaker financials typically face higher interest rates.
• Loan Size: Larger loans usually have lower rates. For example, a loan over £10,000 might offer a 7.1% APR, while smaller loans often carry higher rates, closer to 11.3%.‍
• Market Conditions: Lenders adjust rates based on the Bank of England’s base rate and market competition.

Typical Fees

• Arrangement Fees: Usually 1% to 3% of the loan amount, covering setup costs. Larger loans may have waived or reduced fees.
• Early Repayment Fees: Some lenders charge penalties, typically between 1% and 5% of the remaining loan balance, for early repayment.
• Completion Fees: A one-time fee of 1-2% is charged when the loan is disbursed.

Fixed vs. Variable Rates

• Fixed Rates: Fixed interest rates provide certainty with consistent monthly payments, offering stability, especially when market rates rise.

Variable Rates: Tied to the Bank of England’s base rate, variable rates fluctuate over time. This can lead to lower payments when rates fall but increase costs if rates rise.

Representative APR

The representative APR (Annual Percentage Rate) is often the advertised interest rate for loans, but it applies only to 51% of approved borrowers. Businesses with lower credit scores or higher risk profiles may receive interest rates above the representative APR. Hence, always review the actual rate you’re offered.

‍

Repayment Terms

Repayment terms for business loans in the UK vary significantly based on the loan type, lender, and business needs. Here’s a closer look at the different repayment structures: 

Secured Loans

Due to the collateral involved, secured loans typically offer longer repayment periods, ranging from 5 to 25 years. This results in lower interest rates and manageable monthly repayments, making them ideal for businesses seeking larger sums or long-term investments. However, there’s a risk of losing collateral if repayments are missed.

Unsecured Loans

Unsecured loans generally have shorter terms, from 1 to 5 years, higher interest rates, and larger monthly repayments. They are suited for businesses with strong credit but limited assets and offer quicker access to funds.

Flexible Repayment Options

Loans like revolving lines of credit provide flexible repayment terms, allowing businesses to repay only what they’ve borrowed. Hence, they are ideal for managing cash flow fluctuations. This flexibility is particularly beneficial for businesses with fluctuating revenues or seasonal operations.

Pros and Cons of Business Loans

Business loans provide benefits like funding growth and supporting cash flow, but they also come with risks such as potential asset loss and financial strain. Here's a quick overview of the advantages and disadvantages.

Pros

• Supports Business Growth and Expansion: Business loans provide the necessary capital to fund expansion, invest in new equipment, or enter new markets.
• Cash Flow Buffer: Loans help businesses manage operational costs during cash flow gaps without halting growth.
• Retain Full Ownership: Unlike equity financing, loans allow owners to maintain full control over their business without sharing profits or decision-making power.
• Favourable Interest Rates: Established businesses with strong credit can access lower interest rates, reducing the cost of borrowing.
• Credit Score Improvement: Timely repayments boost a business’s credit score, making future financing more accessible.
• Tax-Deductible Interest: In the UK, interest on business loans is often tax-deductible, reducing the overall borrowing cost.‍
• Fixed Interest Rates for Stability: Fixed-rate loans offer predictable repayment schedules, aiding financial planning.

Cons

• Strict Eligibility Criteria: Many lenders have stringent credit and financial requirements, making it difficult for startups or businesses with weak credit to qualify.
• Risk of Losing Assets: Secured loans require collateral, and if repayments are missed, the business risks losing those assets.
• Increased Financial Strain: Loan repayments can put pressure on cash flow, especially if the business’s revenue fluctuates.
• Personal Guarantees: Some loans require personal guarantees, putting the owner’s personal assets at risk if the business cannot repay the loan.
• Potential Impact on Future Borrowing: Taking on debt may limit a business's ability to secure more financing or lead to higher interest rates on future loans.
• Strict Use of Funds: Certain loans, especially government-backed ones, may restrict how funds can be used, limiting flexibility.

Eligibility Criteria for Business Loans

When applying for a business loan, lenders assess several key factors to determine eligibility and risk. Here is what they typically consider: 

Creditworthiness

Lenders start by reviewing your business credit score, which reflects financial responsibility. A higher score often means more favourable terms, like lower interest rates and longer repayment periods. For unsecured loans, your personal credit score can be assessed. 

A strong personal score can improve approval chances, while weaker credit may require additional guarantees. A clean credit history, free of defaults or missed payments, improves your approval chances. Any past credit issues may lead to higher rates or reduced chances of approval.

Business Financial Health

Demonstrating strong revenue and cash flow is crucial, as these indicators show that your business can manage loan repayments effectively. Strong, consistent cash flow indicates that the company can handle financial commitments without strain. Lenders may also request profitability reports and financial projections to see how the loan will drive future growth and ensure repayments.

Business Age and Trading History

Most lenders prefer businesses that have been trading for at least two years (as this demonstrates stability). Newer businesses may face tougher eligibility criteria. Startups often face stricter requirements and require more detailed business plans or higher personal guarantees to offset the lack of trading history.

Business Plan

A detailed business plan is essential for convincing lenders. Lenders need to understand how the loan will be used, and the plan should include financial forecasts, market analysis, and growth strategies. 

The clearer the loan’s purpose—whether for working capital, equipment, or expansion—the more confident lenders will be in offering favourable terms.

Collateral and Security

For secured loans, collateral such as property or equipment is required, which reduces the lender’s risk and may lead to better terms. However, if the loan isn’t repaid, the collateral could be lost. 

Unsecured loans don’t require collateral but often come with higher interest rates and may require personal guarantees, which puts the business owner’s personal assets at risk.

Legal Requirements

Businesses must be legally registered in the UK to be eligible. Lenders require documents like incorporation certificates and tax records to verify compliance. 

Additionally, owners or directors will need to provide personal identification and financial documents to establish ownership and trustworthiness.

Personal Guarantees

Lenders often require personal guarantees, especially for unsecured loans. This increases personal liability, putting personal assets (homes or savings) at risk if the business defaults.

Other Considerations

Lenders assess the industry your business operates in. High-risk sectors, such as construction or hospitality, may face stricter eligibility requirements or higher rates. 

Lenders also assess your debt-to-income ratio to ensure that taking on additional debt won’t overburden your business. A lower ratio indicates better financial health and increases loan approval chances.

At FundOnion, we streamline the loan comparison process, connecting you with a diverse panel of lenders. Our transparent approach helps you find the best loan option tailored to your specific needs.

Final Thoughts: Your Path to Business Growth

Business loans can drive growth and help your business manage cash flow, expand, or invest in critical opportunities. But it’s first necessary to understand the costs, risks, and benefits. Repayment schedules, interest rates, and fees must be carefully considered to avoid financial strain. Always assess your ability to repay and check if the loan adds value to your business.

In today’s uncertain economic climate, smart borrowing backed by a solid financial plan can take your business to new heights. 

Why not simplify this process through quick, tailored loan comparisons? At FundOnion, comparing loans is fast and easy. Access a diverse panel of lenders, find the perfect loan for your business, and get started in just a few clicks. 

Find your perfect lender now!

FAQs

1. How Do Small Business Loans Work?

Small business loans provide businesses with the capital needed for growth, expansion, or managing daily operations. These loans meet specific business needs and can vary in terms of repayment schedules, loan amounts, and interest rates. The loan approval process typically involves evaluating the business’s creditworthiness and financial health. Lenders assess revenue and the purpose of the loan before approval.

2. How Does a Business Loan Work in the UK?

In the UK, business loans provide companies with the necessary funds to expand, invest in equipment, or manage operations. Loans can be secured or unsecured, and repayment terms depend on the lender. Businesses receive funds in a lump sum or as a revolving credit line, with terms usually negotiated based on the business’s financial standing and credit history.

3. How Do Long-term Business Loans Work in the UK?

Long-term business loans, with terms ranging from 3 to 25 years, are used for large investments such as real estate or high-cost equipment. These loans offer lower monthly repayments spread over a longer period but accumulate more interest overall. Lenders assess creditworthiness, profitability, and the business’s ability to meet long-term financial obligations.

4. How Does Business Loan Repayment Work?

Business loan repayment depends on the loan type and terms. For term loans, repayments are typically monthly and include both principal and interest. Some loans, like merchant cash advances, have more flexible repayment terms based on a percentage of daily sales. Missed payments may lead to penalties or impact the business’s credit rating, and secured loans risk losing collateral.

5. What is a Short-term Business Loan?

A short-term business loan is a financing option for immediate needs, with repayment terms typically under two years. These loans offer quick funding to cover operational costs, manage cash flow, or take advantage of time-sensitive opportunities. However, they come with higher interest rates and more frequent repayment schedules compared to long-term loans.

6. What Are the Benefits of Short-term Business Loans?

Short-term business loans provide fast access to capital, which is essential for handling urgent financial needs. They often have simpler application processes, making them accessible to businesses with moderate credit. These loans are ideal for bridging temporary cash flow gaps and ensuring smooth day-to-day operations, though the higher interest rates and frequent repayments should be considered.

7. How Do Secured Business Loans Work in the UK?

Secured business loans require businesses to pledge assets, such as property or machinery, as collateral. This reduces the lender's risk, often resulting in lower interest rates and more favourable terms. Secured loans are generally used by businesses looking to access larger sums of capital for long-term investments, but they carry the risk of losing the collateral if the business defaults.