A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest. There are a number of different types of business loans, suited to the requirements of different types of business such as bank loans, mezzanine financing, asset-based financing, and invoice financing.
A bank loan is obtained from a bank and maybe either secured or unsecured. For secured loans, banks will require collateral, which may be lost if repayments are not made. The bank will probably wish to see the business’s accounts, balance sheet, and business plan, as well as study the principals' credit histories. Many smaller businesses are now however turning towards Alternative Finance Providers who are offering a number of advantages and reasons to seek business finance elsewhere.
WHAT TYPE OF LOAN IS BEST FOR SMALL BUSINESSES?
Mezzanine finance effectively secures a company’s debt on its equity, allowing the lender to claim part-ownership of the business if the loan is not paid back on time and in full. This allows the business to borrow without putting up other collateral, but risks diluting the principals’ equity share in case of default.
Once considered the finance option of last resort, asset-based lending has become a popular choice for small businesses lacking the credit rating or track record to qualify for other forms of finance. In simple terms, it involves borrowing against one of the company’s assets, with the lender focusing on the quality of the collateral rather than the credit rating and prospects of the company. A business may borrow against several different types of assets, including premises, plant, stock or receivables.
In recent years, it has become increasingly difficult for SMEs to obtain traditional finance from banks. Alternative options are invoice discounting or factoring, whereby the company borrows against its outstanding invoices, with the ability to obtain funds as soon as new invoices are created. It is often questioned which option is best for your business – factoring or discounting – and the answer depends on how the business wants to be perceived by customers. With factoring, the finance company charges interest on the loan until the invoice is paid, as well as fees, and the finance company takes ownership of the debtor ledger and uses its own credit control team to secure payment. With invoice discounting, the business maintains control of its own ledger and chases debts itself.
WHAT WILL HAPPEN IF THE LOAN IS NOT PAID?
Business loans may be either secured or unsecured. With a secured loan, the borrower pledges an asset (such as plant, equipment, stock, or vehicles) against the debt. If the debt is not repaid, the lender may claim the secured asset. Unsecured loans do not have collateral, though the lender will have a general claim on the borrower’s assets if repayment is not made. Should the borrower become bankrupt, unsecured creditors will usually realize a smaller proportion of their claims than secured creditors. As a consequence, secured loans will generally attract a lower rate of interest.
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