How do business loans work?

Business loans come in many different forms. The type of business loans you will want to apply for will depend on your business, the reason you want to borrow and how you intend to repay the money.

Establishing how business loans work is a great place to start if you are thinking about taking out one yourself. If you have questions about the different types of loans available to you, as a small business owner, and you also want to know how repayments work and what your options are, as a borrower, then read on

These are the standard unsecured business loans that you might imagine when considering taking out business finance. You can apply through a bank or online and there’s more choice than ever for smaller businesses looking for funding.

• You apply for funding and decide the loan amount and repayment term
  
  

• You are either approved or rejected
  
  

• If approved, your monthly repayments will be set out for you, including any fees and interest owed.
  
  

• You’ll receive the loan in a single lump sum at the beginning of your term.
  
  

• You will be expected to make the required repayment on time, every month.
  
  

• The repayments will usually be the same or similar each month
  
  

• If you miss repayments, you may be charged a penalty and extra interest charges
  

You can use a standard term business loan for pretty much any purpose. Common reasons for borrowing cash this way is to improve cashflow, to invest in growth, to take on more staff, to pay bills, or to invest in new equipment or machinery.

Banks were the main source of business loans like these for many years. Small business owners would pluck up the courage to visit their bank manager and try to convince them that they would be able to make the repayments.

Banks were infamous for treating small businesses with disdain and many small business owners were treated poorly. Banks were also notoriously strict in terms of their lending criteria for small businesses and this is still the case.

Luckily, there are now so many more options for small business owners looking for financing. Online alternative lenders, such as mcl finance, now offer something very different. We are always keen to hear from business owners who want to grow their businesses and are looking for finance. We will take a borrower's situation, experience, growth plans, support network, financial background and business accounts into consideration when making our lending decisions.

We consider business lending to be a two-way street and will always treat borrowers like partners. And if a borrower runs into difficulties, we’ll collaborate with them to create a repayment plan that works. It's a far cry from the bleak old days of business lending.

There are other forms of credit that businesses can sometimes use to help them to fill gaps in their cashflow, or if they need financing for a specific expensive item.

Invoice factoring, also known as invoice financing, can be a useful form of business finance if you often have to wait a long time for your invoices to be settled. If you find that planning your finances is regularly difficult because cashflow is affected by unpaid invoices, you could use an invoice financier to free up some cash.

• You ‘sell’ your unpaid invoices to a financier

• They pay you the value of the invoices upfront (minus a fee)

• You can use the cash however you like

• The financier then chases your debtors for payment

• They keep the total value of the invoice once paid

Many smaller businesses struggle with unpaid invoices and may even struggle to pay their own invoices, or their staff wages, for example, due to unpaid invoices. This problem can be solved with better financial planning, but, especially in the early years of establishing a business, this can be difficult.

Invoice financing is popular but does have its drawbacks. For example, you don’t get to keep the entire value of your invoices and fees can be high. There is also the risk to your reputation when an invoice financier contacts your customers for payment.

Businesses whose income is largely taken through card machines can apply for a merchant cash advance, also known as a business line of credit. This involves agreeing on a credit limit and withdrawing cash up to that limit. Repayments are then made through your card automatically from your takings.

• You apply for a credit limit with a lender

• Your income and finances are assessed

• If you are approved, the line of credit becomes available up to an agreed limit

• A percentage of your takings are automatically redirected to repay your lender, plus interest

• You may be able to extend your line of credit, or borrow again

A merchant line of credit can be a useful tool for evening out your cashflow. This type of credit can be especially useful for retailers whose income is seasonal. The advantages of merchant cash advances are that you only repay when you have income with which to do so. Repayments are not made every month, they are made when you make a sale. However, you also need to bear in mind that you will lose a percentage of all your sales to repayments, costs and interest charges, which don’t come cheap with this kind of borrowing.

Secured business loans often work in a very similar way to standard term business loans. The difference with secured loans is that they are usually taken out specifically to purchase an expensive item, such as a vehicle, a business premises or a piece of machinery, for example. The loan is secured against this asset, much like a residential mortgage is secured against the value of the property. As a result, this type of loan is also often known as asset financing.

• You apply for the loan with information about the asset

• The lender assesses your application

• If you are approved, you will agree to a repayment term and monthly instalment value

• You will receive the entire loan in a single lump sum

• You must use the cash to pay for the asset, if that’s what has been agreed

• Repayments must be made on time each month

Secured loans can be a good option if you’re looking to make a large purchase. Interest rates will often be lower than for an unsecured loan, as the loan is secured against an asset, which means less risk for the lender. If you fail to make repayments, you stand to lose that asset, which could cause major problems for your business.

If you’re just starting to think about seeking financing for your small business, it’s important to give due consideration to each of the above types of loan. However, a standard unsecured loan can offer one of the most cost-effective ways to borrow. Monthly repayments mean you know the impact the loan will have on your business finances well in advance, so you can continue to plan for the future and regulate our cashflow around the loan, which is very useful when you have bills to pay, payslips to honour and shelves to keep stocked, for example.

Whatever business loan you are applying for, it’s important to go into your application confidently. Business lending is a two-way street and you should always be treated with respect by lenders.