SME business loans can be useful to small businesses at many stages during their life cycles. Loans can help SMEs achieve the growth they need, such as to invest in equipment, staff or infrastructure. Alternatively, loans can provide a lifeline for businesses to improve their cash flow.
However, finding the best SME business loan for your business is essential. The business SME loan market is wide and varied, meaning that businesses now have more options than ever to choose from. While this keeps the market competitive and ensures that companies can find a solution tailored to their needs, it makes it harder to know which is the ‘best’ option.
In this blog, we have put together the different SME business loan types available to SMEs to help you determine which is best for your needs.
Types of loans
In the current market, there is more than one ‘type’ of loan. Each type has unique characteristics, which can be both advantageous and disadvantageous. It is vital to understand each type and how they can work for your business.
Secured versus unsecured
Loans will fall into one of two categories: secured or unsecured.
With a secured loan, you need to provide some form of security for the provider to accept you for funding. This covers asset-based finance and may involve the requirement of providing a personal guarantee. With these loans, your business assets (such as machinery or other high-value equipment) or the finances of the personal guarantor are used as collateral. With an unsecured loan, this collateral is not required, however a personal guarantee is invariably required.
Due to their nature, secured loans do pose a risk in that if you can’t pay the balance, the provider can seize your business assets. This can leave you without valuable equipment needed for your operations, resulting in a halt to productivity. In the case of a personally guaranteed loan, you will be expected to dip into your personal reserves to cover the loan.
However, due to the security offered, secured loans tend to be higher in value and easier to come by. Unsecured loans tend not to exceed £250,000, which make it harder to achieve significant investment in your business, and may have shorter terms.
If you are confident that you can meet repayments and have the assets in place to use as security, secured loans are best for allowing you to receive high-value funding over more extended periods. Secured loans are also easier to apply for if you have a poor credit score, as the guaranteed element provides more confidence to the provider.
However, if you are seeking a small loan over a shorter time frame, or do not have assets in place to use as collateral, an unsecured loan may work better for you.
Government-backed
Government-backed loans, as the name suggests, are loans that are either approved, underwritten or guaranteed by the government. Many commercial providers now offer these loans.
Government-backed loans are usually available to provide relief to companies in times of hardship (such as seen with the COVID-19 pandemic), to support companies where directors have fewer personal assets or to encourage businesses to meet certain benchmarks.
The benefit of government-backed loans is that they usually come with lower interest rates or can even be interest-free to set periods. This means that repayments tend to be more manageable.
However, to get a loan, there will be set criteria you need to meet, which may relate to your industry, products, services or the way you operate internally. For example, typical government-backed loans are associated with innovation and use of technology within operations. You can find a list of available loans on the government financial support search tool.
If your SME meets the required criterion, government-backed loans are usually worth pursuing due to their benefits. However, if your company does not fulfil the requirements, you will need to seek out alternatives.
Fixed-rate versus variable rate
Another way in which loans vary is how interest is calculated on them. With a fixed-rate loan, the interest rate remains the same over time (usually a fixed period, outlined by your provider).
With a variable rate loan such as an overdraft or invoice discounting, the interest rate is subject to change as it is invariably linked to the base rate set by the Bank of England or the bank from which you are borrowing.
Some businesses may prefer fixed-rate loans as it means repayments stay the same every month, making for easier accounting. However, it also means you won’t be able to take advantage if interest rates should fall.
So, which you choose depends on whether you are willing to take the risk of missing out on low-interest rates (with a fixed-rate loan) versus the risk of having payments increased in line with increasing interest rates (with a variable rate loan).
Short-term versus long-term
When taking out a loan for your SME, you need to consider how long you are willing to make repayments. Short-term loans may last only a few years, whereas long-term loans can last up to 35 years and tend to be linked to commercial property.
Generally speaking, the longer the term of your loan, the lower your monthly repayments will be. However, interest will be applicable on the loan for longer, which means you may end up paying more overall.
Short-term loans are helpful if your business needs a quick injection of cash, or if you do not want the burden of long-term repayments hanging over you. However, long-term loans are useful if you are borrowing a larger sum of money or need more sizeable financial support.
Loan providers
Gone are the days when you could only get a business SME loan from your bank. Now, many different providers are offering a variety of SME business loans. We have broken down the different types of providers and what you can expect from each.
Banks
The most traditional lenders are banks. Banks will usually offer a range of different loan types allowing you to compare and contrast the different options.
When considering bank loans, it is essential to shop around as different banks may offer more competitive interest rates. You can choose a high street bank or a digital bank, which are becoming increasingly popular.
Generally speaking, the interest rates will be determined by the Bank of England base rate at that time plus a %. Still, there will be some variation between banks. If you are already a customer of a specific bank, they may be able to provide you with a loan offer based on your account performance.
If your company has a poor credit history, you might find that banks are less willing to lend to you.
Alternative lenders
Beyond banks, many alternative providers offer loans. There are even specialist small business orientated providers, with loans that are tailored to the unique needs of your SME.
The advantage of these alternative providers is that they can provide quicker access to funding that you would not get from a bank. They also tend to be competitive, however you do pay a premium for speed.
These lenders sometimes offer unsecured loans and will have fewer hoops that businesses need to jump through to be accepted, which can allow companies who would perhaps be rejected by a bank get the finance they need. In this sense, the loans offered can be more flexible, depending on your business needs.
A lot of these lenders tend not to be regulated by the FCA as they do not lend to members of the public, i.e. commercial loans only, and in addition will not lend to sole traders or partnerships under £25,000.
Peer to peer
Peer to peer lending (otherwise known as P2P) is when your loan comes typically a syndicate of smaller investors.
As peer to peer lending cuts out the middle-man role, usually taken by a bank, and instead utilises online platforms to bring lenders and borrowers together, better rates can be enjoyed by both sides. Borrowers can also enjoy more flexible loan terms.
However, peer to peer loans can be risky for those being lent to since they are dealing with a syndicate of lenders, who are interested in their returns. This means they are unlikely to be sympathetic to your needs in the event that you default. The platforms have strict rules around compliance, and you may find that you are hot with substantial costs and fees that you did not expect. These are also a relatively new form of funding, so many businesses may have a preference for the tried-and-tested loans available from banks and other lenders.
If you can find the right lender, however, and are willing to explore peer to peer funding, it could be an excellent solution for your business.
What else should I look out for?
Now you have an oversight of the different loan types and pros and cons of each, you can determine which is the best option for you. You can always seek advice from an independent advisor for additional support.
However, there are some other things to bear in mind when searching for that perfect loan. One example is any additional costs associated with the loan, such as arrangement fees – these can vary considerably between bank loans and the alternative provider loans. These are invariably added to the cost of the loan and interest is payable on this as well as the principal loan. These costs may not be immediately visible, so be sure to check thoroughly before you commit to a loan.
You should also check the application processes for any loans you are interested in. As already mentioned, some loans will have criteria you need to fill to be eligible, so make sure you can meet this. If you qualify, consider what you need to do to apply. In some cases, applications can be lengthy, and you will need to provide the required documentation such as accounts, copies of bank statements, management accounts, aged debtors/creditors and personal asset statements, so you should feel comfortable in doing so.
Finally, consider how quickly you need the loan. If your business requires cash urgently, a long-term bank loan requiring a drawn-out application form, managers writing credit papers and a credit team reviewing your application will not be ideal. Instead, you may wish to utilise short-term, unsecured loans from an alternative lender. Understanding what you need and when will allow you to filter your options to a loan that is right for you.
Our team of experts have experience across a range of finance types, so we can help you to find the right funding solution for your unique business challenges.
Please call the team today for a free consultation on 0203 327 0567 or email [email protected].