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Small business loans explained

Read our guide on what small business loans are, why they are useful, and how you could use one to help your business find success.
Small business loans explained
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Updated on 15th June 2020

For small businesses across the country, having access to the funds needed to sustain, grow and adapt their operations matters. With the right funding, a business may be better equipped to tap into new opportunities in the market and create the right internal environment for growth.

This could mean having a well-paid team that is highly motivated, or the best equipment needed to do the job and create a competitive advantage in the market. That’s where a business loan could be of use.

In this article, we will explain:

If you’ve already decided that a small business loan is the right option for you, check out our guide on how to apply for one. Otherwise, let’s dive into the meaning behind the phrase ‘small business loan’.

What is a small business loan?

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A small business loan is a loan offered by a bank, or alternative lender, to an SME (Small-Medium Enterprise) with a condition of repayment. Put simply, you can take out a small business loan to get access to money in the short term, which you’ll pay back with interest in the future.

The types of loans available for small businesses often vary from those secured by large businesses. That’s because small business owners face a different set of challenges; typically having a smaller range of product/service offerings, a smaller customer base and less cash in the bank to sustain themselves in case of sudden threats to their business model.

All of these factors affect the amount of risk a lender is taking by loaning money.

What types of small business loans are there?

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There are many different types of loans available to SMEs, however the majority of them fall into two categories. These are:

Secured loans

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With a secured loan, the borrower is required to provide an asset (such as a property, or equipment owned by the company) as insurance - in case the business is unable to repay borrowed funds. If the loan is not paid back, the asset must be sold in order to repay the lender in full.

Unsecured loans

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With an unsecured loan, an asset is not required by the lender in order to get a business loan. This style of loan is particularly useful for businesses that may not actually have an asset to secure a loan against. Personal guarantees are usually required for this type of loan instead, which means the business owner (or sole trader) is liable if the business is unable to pay the loan back.

One notable difference between secured and unsecured loans is how they vary in interest rates. Recipients of secured loans typically gain access to slightly lower interest rates than they would by taking out an unsecured loan. This is because of the amount of risk taken by the lender- which is reduced when an asset is offered as insurance.

In reality, though, not all business owners have access to a high-value asset to stake as insurance - so it’s fortunate that unsecured business loan lenders compete with each other to offer attractive interest rates - which can sometimes make these loans more affordable.

How can I use a small business loan?

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There are plenty of different reasons why a business owner may take out a business loan, but most of them centre around a desire to improve the business’ performance. Some of the better known reasons include:

1. Increasing or sustaining working capital

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If your business’ working capital is in a good state, the likelihood is that it’s experiencing growth, has a stable flow of sales, and has a good-looking balance sheet. Sometimes a cash injection could help with maintaining this growth - or it could be used to help a business that finds itself in a difficult spot financially.

2. Investing in equipment

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Having the right tools to meet the needs of your customer is important to each and every business. Sometimes buying equipment gives businesses access to new opportunities they might not have had otherwise. For example, they may become more able to compete for new business alongside their competitors, or they may simply find themselves having the right equipment needed to maintain their services during a period of high demand.

For example, for SMEs that rely on transport to deliver a service - a company vehicle may be considered an important purchase. Or, if a construction company were to own a new heavy-duty vehicle, it could create more opportunities for them to win different contracts. A business loan could fund a vehicle to help provide a better service while paying a loan back in manageable instalments.

Alternatively, you may need less specialist business equipment for the day-to-day running of your business. In this case, a loan could help with covering the cost of buying computers or office equipment, for example.

There’s a lot of strategy behind buying equipment; a business owner may have to decide between buying cheap equipment for the short-term or investing in quality equipment that could potentially save them money in the long-run. So, a business loan could help finance the purchasing of equipment and allow you to choose a repayment plan that works for your business and cashflow.

3. Maintaining cash flow

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It’s important that businesses are able to keep on purchasing enough inventory to meet customer needs, but also that they’re able to continue to pay their employees and make a profit. When short-term cash flow becomes an issue for whatever reason; an SME loan could help a business cover its costs until the issue is resolved.

What’s more, aside from day-to-day costs, business loans may be a helpful option for helping to tackle large or unexpected bills. This is especially true if you’re waiting for a large invoice to be paid that could affect your business’ operation cycle, or if you need to pay your supplier on time- which could help you maintain a positive reputation.

4. Buying inventory

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If your business sells a physical product, you’ll need stock or materials for production. A business loan could help finance additional inventory that could be converted into profit. It could also give your business the opportunity to buy the best products or in bulk for a potential further discount - which could improve your working capital.

5. Funding an expansion

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Whether you’re upscaling to larger premises, looking to expand your team, or looking at making an acquisition of another business, a business loan could help to cover any costs that occur when growing your operations. You can read about how this has been done successfully before by one of our current clients, Clear Vision Financial Ltd.

It’s difficult to have full visibility and foresight over any unexpected costs that may arise during your expansion, so a business loan could serve as a handy buffer in case you are hit with any sudden challenges. It may be worth finding out how quickly you can get a loan from your provider of choice- especially if you suspect that your financial needs may be time-sensitive.

6. Hiring more staff

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Having the right staff is vital to the success of your business. Having access to enough money, then, to bring in the right team and empower them to succeed is something that could be helped by a business loan - with examples including recruitment fees or initial wages.

StrawberrySocial took out a loan with Esme to enable them to invest in new team members, and in developing their marketing activity so that they could continue to grow.

7. Investing in marketing

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Speaking of which, having a marketing strategy is crucial for businesses that are looking to make their brand well-known in the market and really connect with their customers. A business loan could help finance marketing plans, and all the additional costs that come with them - which could include advertising, social media presence or PR activity.

It could also help to fund professional advice from an agency or consultant to help form and execute your marketing strategy to the maximum effect with your target audience.

These seven examples of how you could look to use a business loan outline some of the most popular and well-known methods, however they aren’t the only ways in which you could use a loan. Ultimately, having a business loan could give you the opportunity to invest in your business and potentially improve its future prospects and profit.

Small business loan rates explained

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When you apply for a business loan, the lender will most likely conduct an analysis of you and your company to assess how equipped they think you are to pay back the agreed loan amount.

A key factor that your average lender may take into account is your motivation behind taking out a loan; what are you trying to achieve? There’s also a good chance that the lender will want to evaluate your credit history to get an understanding of your track record with finance.

Some key terms to be aware of include:

  • Interest rate – An interest rate is a percentage charged on the total amount you borrow. It makes borrowing desirable for a lender, and it may be worth understanding whether the interest rate on the loan you’re looking to take out is fixed or is variable and may fluctuate.
  • APR – This stands for Annual Percentage Rate, which is the official way of measuring an interest rate. It takes into account annual interest, and any additional charges or fees which may be applied to a loan, and is used to help you fully understand the cost of borrowing.
  • Repayment schedule – A repayment schedule is something you’ll agree with a lender when taking out a loan. Some things to look out for include whether the repayment schedule is fixed or varies, if there are any early repayment fees and how frequently repayments must be made. At Esme, all of our loan repayments are made monthly.

If you think a loan may be the right choice for your small business; perhaps you’ve spotted an opportunity for growth or are looking to fortify and maintain your operations, check out our ‘How to apply for a small business loan’ guide for a step-by-step walk through of the entire process.

SME loan FAQs

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Let’s take a look at some frequently asked questions around business loans and dispel some myths.

Could you get a small business loan without collateral?

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Yes. This type of loan is called an unsecured business loan- and requires a personal guarantee from the borrower as insurance.

Could you get a small business loan with bad credit?

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The answer to this is maybe. Some lenders may require that you have a guarantor before finalising a contract. This extra layer of insurance helps the lender mitigate risk, but it’s possible that by demonstrating a good turnover or offering assets as insurance; you could get a loan even with bad credit, or no credit history at all.

Is there any advice around when to get a small business loan?

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It’s a misconception that getting a small business loan means that your business has failed or is struggling. Many successful business owners use loans to move their business from strength to strength; growing and expanding.

It may be worth assessing the state of your business’ finances, your forecasts for the future, and key opportunities emerging in your market/industry to help you decide whether it’s the right time for you to look for a business loan. If you have any additional questions about business loans or require further support- you can reach out to us at accountsteam@esmeloans.com.

How could Esme help?

These are difficult times for many businesses, so it’s important now more than ever, to take good care of yourself and your team. If you’re concerned about your business being impacted financially due to coronavirus and want to understand the support available to you, please visit our advice page for information.