A business loan is worth it when the money will earn more than it costs, and when the business can carry the repayments even in a quiet month. If either half of that fails, do not borrow. A loan that buys something which makes you money is an investment. A loan that covers losses, or funds a plan you cannot put a number on, only delays the problem.
Key Takeaways
- Borrow to buy something that pays for itself, such as a vehicle, equipment or a clear opportunity to grow your business.
- Do not borrow to cover ongoing losses or for a purpose you cannot define.
- Repayments are fixed. Your sales are not. Test the repayments against a bad month, not an average one.
- Check fees, security and personal guarantees before you check the rate.
- Try cheaper or less risky business finance first, then borrow if it does not fit.
How business loans work
A business loan is a lump sum paid into your business account, which you repay over an agreed period, usually in monthly instalments that cover both the amount borrowed and the interest. The lender looks at your turnover, your credit history and what the money is for, and aims to make sure the repayments are realistic.
The mechanics are simple. What matters is what the money does once you have it. That is the first test.
The first test: will the money earn more than it costs?
Business borrowing is not like personal borrowing. A personal loan buys something you want. A business loan should buy something that produces a return.
The question is: if I spend this money, what comes back, and is it more than the interest and fees I will pay?
Some plain examples of money that can earn its keep:
- A new vehicle that is cheaper to run, looks more professional, or lets you serve more customers.
- Equipment that lets you take on work you currently turn away.
- A gap in the market you can see now, which may be gone if you wait to save up. A cash injection at the right moment is the main case for borrowing.
The common thread is a specific, defined need. If you cannot say in one sentence what the money buys and how it pays you back, the answer is not yet. Borrowing for a vague or non-essential purpose is generally unwise, because you keep making repayments long after the money has been spent. A good business idea still needs a number attached to it.
There is also a sensible step before the numbers. If you can meet the need from savings or retained profit, think hard about doing that instead. Keep a buffer for surprises and for dips in income. Spending your last cushion to avoid a loan can be as risky as the loan.
When a loan is not worth it
There are two places I would draw the line.
Covering losses. If the business is losing money and the loan is keeping it afloat, the loan has not fixed anything. It has added a fixed monthly payment to a business that was already struggling. Loans suit paying for assets, start-up capital, and cases where the amount you need will not change. Taking one out for ongoing expenses is not a good idea, because you may find it hard to keep up the repayments.
Some lenders describe a loan as a safety net through a slow patch. For a short, well-understood gap, such as seasonal stock, that can be reasonable. If the slow patch is really a structural problem, borrowing only makes it more expensive.
No clear payback. If you are hoping a project will work out, rather than expecting it to, that is not a basis for debt. Lenders want a business plan and forecasts for this reason: they want to see that the money has a purpose and a route back.
The second test: can the business carry the repayments?
A good return on paper does not help if the repayments land in a month when cash is short.
Most small business loans have fixed monthly repayments. That helps, because you know the figure in advance. It is also unforgiving, because the payment is due whatever your sales did that month. If your customers pay late, you may struggle to meet it.
A practical way to test this:
- Write down the monthly repayment, including any fees.
- Build a 12-month cash flow forecast that sets sales and other income against running costs, fixed costs, wages and the new repayment.
- Run it on a bad version of the year. What if your best customer pays 30 days late, or a quarter is slow?
- Check you can still pay everyone, including yourself.
If the business only works when everything goes right, it cannot carry the loan. If it still works on the bad version, it can. Every business owner should do this before signing, because the lender's sums assume the good version.
Be wary of variable-rate loans. The repayment can move, which makes planning harder. Most small business loans are fixed rate, so you can usually avoid the problem.
Plan for a smaller loan than you asked for, too. A lender may approve less than the amount requested, deciding that you do not need the full sum or that it is too risky. If your plan only works at the full amount, you have a problem before you start.
Our how much can I borrow tool gives you a rough sense of where you might land before you make a loan application.
Types of business loans and financing: which fits?
The right type of loan depends on what the money is for.
- Secured loans are backed by an asset such as property, machinery or a vehicle. The lender can claim it if you do not repay. Larger amounts are usually secured.
- Unsecured business loans have no asset behind them, so they are quicker to arrange, but they may carry higher interest because the lender takes more risk.
- Short-term loans cover seasonal stock or a temporary gap. Long-term loans suit bigger projects, because spreading repayments makes growth that takes time to pay off easier to manage.
Match the term to the life of what you are buying. Borrowing over five years for something that wears out in two is a quiet way to lose money.
Business loan vs personal loan
A personal loan is assessed on your own credit score rather than the business's, so it can suit a very young firm without trading history. It is usually smaller than a business loan, and you are personally liable if the business cannot repay. Not every lender allows personal loans to be used for business, so check first. A business loan can be larger and helps the company build its own credit record, but the loan application is often longer and the eligibility criteria stricter.
Advantages and disadvantages of a business loan
| Advantages | Disadvantages | |
|---|---|---|
| Control | No shares sold, no one else sharing future profits | None, but you carry the repayment risk alone |
| Speed of growth | You can act now rather than saving for years | Fixed repayments start whether or not the growth arrives |
| Flexibility | Once drawn, the money can usually be used as planned | Loans are not very flexible; early repayment can carry charges |
| Approval | A bank loan from an established lender brings security | Applications can be long and eligibility strict |
| Amount | Larger sums than most alternatives | You may be offered less than you asked for |
The main disadvantages of borrowing money in short: repayments you must make regardless of sales, fees and interest on top, possible loss of an asset or personal exposure, a lengthy application, and damage to your credit file if it goes wrong.
The hidden costs to check
The interest rate is the number everyone looks at first. It is rarely the whole cost.
Fees. Some lenders charge nothing to set up or repay early. Others do. One lender's one-off fee when the loan is issued varies between 1.5% and 6%. Another charges 5% to 6% on loans longer than 12 months and nothing on shorter ones. Some lenders charge early repayment interest, while others let you make extra repayments freely. These terms differ by lender and product, so ask for the all-in cost in writing.
Rates vary widely too. Representative APRs (the rate lenders must show so loans can be compared) on high street small business loans run from around 8.6% to 16%, and one alternative lender quotes 18.9% a year at the lower-risk, short-term end. Missed-payment penalties can be costly.
Security. If the loan is secured against your home, you could lose your home. If it is secured against business assets, you could lose the assets you trade with.
Personal guarantees. An unsecured loan has no asset behind it, but the lender may ask for a director's guarantee instead. That means they may go after you personally if the loan is not repaid. For a limited company director, this is where company debt becomes your debt. Read that clause before you sign and do not treat it as boilerplate.
Your credit file. A refused application can lower your credit score and make future borrowing harder and more expensive. Applying everywhere to see who says yes is not free.
Am I eligible, and what about poor credit?
Lenders look at the financial health of the business, its credit history, and often the owner's personal credit score too. The lower the score, the harder a loan is to get. Newer businesses can find this particularly hard without a trading history, and most lenders expect accounts, bank statements or forecasts.
With poor credit, expect a smaller offer, a higher rate or a decline. Improving your credit history, tidying the accounts and reducing existing debt before you apply is usually worth the wait. Lenders also want to see that you have other loans under control.
Start-up loans for a new business
For a startup or new business, the Start Up Loan is a UK government-backed scheme worth knowing about. It is technically a personal loan for business purposes. Under the scheme's own terms you can borrow between £500 and £25,000 at a fixed 7.5% a year over one to five years, with 12 months of free mentoring. It is unsecured, but you are fully liable if the business fails, and a default can seriously damage your personal credit. Applicants with poor credit or an IVA are unlikely to be approved.
Is it advisable to take a loan to start a business? It can be, if the money buys something specific and your cash flow forecast holds up. Just be clear that you carry the risk personally.
Other options to try first
A bank loan is one tool, and not always the right one. Match the business finance to the job:
| Option | Suits | The catch |
|---|---|---|
| Existing funds | Needs you can cover from savings or profit | Keep a buffer, or you swap one risk for another |
| Overdraft | Short-term gaps; you only borrow what you use | The bank can ask for the money back at any time |
| Invoice finance | Cash tied up in unpaid invoices | You lose some profit on each invoice; it may limit other funding |
| Merchant cash advance | Unpredictable card sales | Set fee, repaid as a fixed percentage of each sale |
| Leasing or asset finance | Equipment | Can cost more than buying; if you stop paying you lose the asset, not your home |
| Bridging loan | Short-term finance while waiting for money owed to you | Short-term only |
| Grants | A specific project | Competitive, usually matched funding, not for projects already started |
| Equity finance | Larger growth plans | You sell part of the business; only limited companies can do this |
On invoice finance, a worked example helps. If a customer owes you £40,000, the financier might advance 85% up front, which is £34,000. The remaining £6,000 comes to you once the customer pays, less the interest and fees. You get the cash quickly, but you pay for it.
Loans suit assets and fixed-amount needs. Overdrafts and invoice finance suit cash flow that goes up and down. If you are an established limited company and security is the sticking point, the Growth Guarantee Scheme may help. Spreading your funding across more than one source also reduces your reliance on debt, which matters for SMEs and any other small businesses with lumpy income.
So is it worth it?
My straight view: borrow when you can name what the money buys, show how it pays for itself, and run the repayments through a bad month and still be standing. Do not borrow to hide losses, to fund a hunch, or to avoid a conversation with your accountant. These are big financial decisions and they are easier with an accountant reading the forecast.
If you pass both tests, a loan is a perfectly good tool. If you pass one, wait and fix the other.
Frequently Asked Questions
Can I use a business loan for day-to-day costs?
It is not a good idea for ongoing expenses, because you may struggle to keep up repayments. A short-term loan for a known, temporary gap such as seasonal stock is a different matter.
Does a refused application affect my credit?
Yes. Being turned down can lower your credit score and make later borrowing harder and more expensive.
What if the lender offers less than I asked for?
It happens. Lenders sometimes decide the full amount is not needed or is too risky. Plan in advance how you would deliver the project with a smaller sum.
Is a personal loan cheaper than a business loan?
Not necessarily. Rates depend on your credit history and circumstances, and on whether the loan is secured. A personal loan is usually smaller and may need repaying sooner, and you are personally liable either way.
Can I repay the loan early?
Sometimes without charge, sometimes not. Some lenders charge early repayment interest and some do not, so check before you sign.
Testing repayments against an average month instead of a bad one, and signing a personal guarantee or security clause without reading what you stand to lose