A Guide To Business Startup Loans

Starting a new business takes time, effort and money, and while many of us can dedicate the first of these two factors for nothing, money is a different matter. Debt is a normal part of business life, but how do you finance turning your business dreams into your business reality? The answer, of course, is to borrow, but in a marketplace saturated with different options to do this, what are those options and how do you decide which is the best for you?

Understanding Business Startup Loans

Startup loans can be the bedrock of a successful business. They come in many different shapes and sizes, tailored to suit the different needs of different types of businesses. Like all financial products, they’re only accessible to those who pass the eligibility criteria. Broadly speaking, these are the most common criteria that a lender will be looking at when assessing an application:

• Business plan: Your business plan needs to explain the size of the opportunity and show how you’ll take advantage of it. You should also show the lender specifically how the loan would be used. Key risks should be identified, along with a plan for managing them should things not go as you’d originally planned.

• Financials: Provide a budget showing how you’ll afford repayments. Make sure that you keep your figures and assumptions realistic; those underwriting these loans will know what they’re looking for, and applications based on unrealistic financial assumptions will likely be rejected. As a startup, you will be expected to have made some form of financial investment into the company yourself.

• Creditworthiness: Just the same as individuals, businesses have a credit rating or credit score. Keeping this as good as possible is extremely important for existing businesses looking to grow. If your company is a new startup, your personal credit score will be a factor.

• Security: Not all loans are secured but for many–in particular for larger amounts of money–you’ll be expected to provide some form of collateral as ‘security’ in the event that you default on your loan. This comes with a degree of inherent risk. Should you provide security and default on payments, that collateral will be at risk. The very nature of limited companies reduces the personal liability of directors in the event of anything going wrong, but this isn’t always the case. You may be required to make a personal guarantee, meaning that you become legally liable for the debt should your company fail to maintain payment.

Business Startup Loan Types

At their most fundamental level, startup business loans come in two forms:

• Term loan: A lump sum you get all at once, with a regular repayment schedule over a set period of time. Interest rates are lower, but the amount that you borrow will be fixed, meaning that if you need more money you’ll need to take out another loan, and this can be an inconvenience and expensive, and that’s in the event that you get approved for more than one; getting a second business loan because you’ve spent your first one can be extremely difficult.

• Line of credit: An agreed amount that you can dip in and out of when you need to with flexible repayment amounts and interest charged only on the amount of money you use. A line of credit allows for greater flexibility on your part, but they tend to come at a higher interest rate.

This borrowing may come from one of several different sources:

Business bank loan

Business bank loans are traditional loans from established banks such Lloyds TSB, Halifax, Barclays, RBS, HSBC and Santander in the UK, or through smaller ‘challenger banks’ such as Monzo or Revolut. Business loans are offered as secured (requiring security in the form of an asset) or unsecured (no assets required as security). Typically, the shorter the terms of the loan, the higher the interest and monthly repayments.

They have flexible payment terms (anywhere from one month to 30 years) and fixed repayment rates, which give you absolute confidence about what you need to repay and when, and under the right circumstances they can offer access to large amounts of financing, but they often require assets as security, while the fees for late or missed payments can be high, and interest rates can be high as well.

Personal loans

Since many start-ups are still too new to have a track record, you may look to take out personal loans. In this case, the lender will only consider your personal finances, not your start-up finances. Collateral may not be required and, unlike many specialist business loans, the lender has no say in how you use the money in the daily operations of your business.

But you are personally liable for the loan, even if you’re not the sole owner of the business, and approval will be dependent on you having a good credit score, while your credit score will be at risk should you struggle to maintain repayments. Interest rates for personal loans tend to be higher than for business loans as well, while there’s usually a lower limit to what you can borrow.

Equipment Financing

Equipment financing covers the costs of equipment and machinery. You’ll have monthly repayment terms over a set period just as you would with a more general loan. Equipment and machinery can be expensive if you’re a new business with limited or no revenue that needs these items but, of course, this sort of financing can only be used to purchase equipment or machinery. Interest rates can be highly variable, but some finance companies of this sort may run promotional interest rates on certain types of equipment, so it’s best to keep your eyes open if you think you’re going to be looking in this area of the marketplace.

‍Business credit cards

Business credit cards are one of the simplest finance options for startups. They work the same way as personal credit cards but are based on your company income rather than your personal income, which usually means you can borrow more. Business credit cards are flexible; they can be used for covering ongoing or unexpected expenses, and sometimes come with perks such as cash back, free travel insurance, 0% interest periods or reward points.

‍You’ll get a bigger line of credit if you have a strong business credit score, but business credit cards aren’t always available for new startups which cannot yet demonstrate their financial viability, while both fees and interest rates can be expensive, especially if you use them to borrow cash.

Crowdfunding

We’re starting to move away from the ‘traditional’ ways of business financing now.  Crowdfunding means pitching your business idea to consumers or investors and giving something in return for their investment. It facilitates peer-to-peer lending.

‍There are crowdfunding platforms that present various opportunities to investors that you can use. It works best for new businesses that have built up a social following and can tap into that network to attract more interest. There are different types of crowdfunding, including donation or reward crowdfunding and investor crowdfunding, but there are no guarantees that you will raise the amount that you hope to, and you may have to give up some degree of control of your business if you go down the investor crowdfunding route. That said, it can be a great way to develop customer loyalty.

Government Start-Up Business Loans

As part of ongoing attempts to encourage greater entrepreneurship, the government offers an array of startup loans and grants to SMEs.The government’s ‘Start Up Loan’ was introduced in 2012, and is available to businesses which have been trading for less than three years. You can apply for up to £25,000 per individual or up to £100,000 per business, if you have business partners.

The scheme also comes with one year of mentoring and a low fixed interest rate of 6%. They don’t require collateral, but they are personal loans, meaning that your credit score is at risk if payments are not maintained, while certain business types–including property development, gambling and banking–are excluded. Further information and details on how to apply for these are available through the government’s Start Up Loans website.

Factors to Consider When Choosing the Right Startup Loan for Your Business

How much do I need to borrow?

Business loans come in a vast array of shapes and sizes, from a few hundred pounds to millions, so the very first step in your process should be to understand the amount of money you need. If it’s to pay for investment into the company, for example, such as new equipment, get quotes from the suppliers first.

Can the business afford to repay it?

Lenders are required to carry out affordability checks on all new customers before approving any lending, but this doesn’t alter the fact that the ultimate responsibility for ensuring that it’s repaid rests with your company, or even with you personally, if your loan is a personal loan or a loan which comes with a personal guarantee.

Do I need to apply for a loan?

There may be other options open to you. If you have personal savings that you can use to fund your business, this will save you a considerable amount of money. Alternatively, friends or family may be able to lend to you.

What’s my credit score like?

For startup businesses (and certainly in the case of businesses that have not been trading for long), the quality of the loan that you will be approved for will be largely determined by your credit score. Having a damaged credit score doesn’t preclude you from getting a business loan, but you should be aware that the amount that you can borrow will be limited, while the interest rate will be higher.

How to Apply for a Business Start-Up Loan

1. Decide how much you want to borrow: While a lender may offer you £20,000 for example, this doesn’t mean you need to borrow that amount. Work out exactly how much money you need to borrow and that you’ll be able to afford the repayments.

2. Choose your loan term: A loan’s term is the period of time you’ll be repaying it. You may decide a year is long enough to pay back what you owe, or you may prefer to spread the cost over five years. Just remember the longer you take to pay back the loan, the more interest you’ll be charged.

3. Provide your details: Your lender will ask for your personal details and details of your new business. Make sure you have all this information to hand so the application process is smooth sailing. You can streamline this process by providing:

   • A business plan: Explain the size of the opportunity and show how you’ll take advantage of it. You should also show the lender specifically how the loan would be used. Key risks should be identified, with a plan for managing them.

   • Financials: Provide a budget showing how you’ll afford repayments. If the loan is for an existing business, the lender will want two years of profit and loss reports and possibly tax returns. The budget should be realistic and based on sound assumptions. Remember, those who underwrite the loan will already know what’s realistic and what isn’t!

   • Security: Not all loans are secured but if you want to borrow a lot or if your business is brand new, you’ll likely be expected to offer collateral in return. Providing some form of security lowers the lender's risk if you stop making payments.

   • A Personal Guarantee: A personal guarantee may also be an option, but this will come at personal risk to you if you can’t repay the loan.

When you come to decide which bank, credit card company, or another lender you want to borrow from. Make sure to compare lenders - they’ll offer different interest rates and deals - and keep an eye out for promotional interest rates and other offers that different lenders may offer.

What Collateral Might Be Required for Securing a Business Startup Loan?

There isn’t a huge range of options, should you be required to provide collateral for a loan. Property or land is the most common. Much like a mortgage on a home, which is a form of secured loan, you can put up any property or land owned by your business as collateral for a loan. Alternatively, the lender may agree to inventory or invoice financing. Inventory financing involves offering the computers, machines and materials you use to conduct your business to secure finance. Commercial vehicles are among the more common assets used here. Invoice financing, in which you use outstanding invoices as collateral to borrow money, may also be an option with some lenders.

Getting Approved for a Start-Up Loan

All lenders have different criteria and requirements, and there is no silver bullet which will guarantee that you will be approved for a loan from anyone. But there are certain things that you can do which will help your application.

Be realistic with your business plan

If you’re submitting a business plan, make sure that it’s a realistic one. Overstating your expectations for your new business will do your application more harm than good.

Have a budget document

Being able to send a fully costed budget to a prospective lender will allow them to see exactly how you’ll be able to make your payments to them. Technology can help with this. There are, for example, many apps now available which allow you to document and track your company’s financial position.

Let them know if you can offer collateral

If you’ve got collateral and you’re happy to offer it, let them know! Offering collateral secures your debt to a lender, and may increase your chances of getting your loan approved.

Check your credit rating first

For new startups, a personal loan may be your best option. But if this is the case, the attention of the lender will turn to your personal credit history as a guide to how credit-worthy you (or your business) may be. Lenders are legally required to report an accurate record of your credit history, so if there is anything negative on it which is correct, they will not remove it upon request.

But mistakes can happen and missed payments or previous defaults can be wrongly documented, and if there is anything incorrect showing make sure that this is corrected before you start your application. Rejected applications for credit can negatively impact your credit score, so it’s important to get this straight before you begin the application process.

How Long Does the Approval Process for a Startup Loan Usually Take?

The approval process for startup loans can take longer than for personal loans because a lot of information has to be checked first. It is possible for a response to be received within a few hours, but it may take weeks or, in complex cases, months to get a final answer.

To manage your expectations, check how long the process is with the lender before completing the application. If you need ready money quickly, some loan types may not be for you, and repeated applications can negatively impact you, even if this is because they’re not completed rather than rejected.

What Should I Do if My Start-up Loan Application Gets Rejected?

Contrary to what people who have been rejected for loans may occasionally say, lenders don’t want to reject your credit application. They do so when their appetite for risk doesn’t match yours.

The first thing that you need to do is… don’t panic! Find out why the application has been rejected. If your application has been rejected, lenders are required to give you a reason. This may have happened in error. In larger financial institutions, a proportion of the underwriting process is likely to be automated, filtering out those who ‘the data’ feels are unsuitable. However this data can be incorrect, and you can request that your application be reviewed, though this is no guarantee that it will be approved.

You should also bear in mind that different lenders have different lending criteria, and that rejection from one doesn’t mean you’ll be rejected by others. It remains a common myth that there is such a thing as a ‘credit blacklist’ which prevents certain people from obtaining credit from anywhere. This does not exist. All credit applications are dealt with entirely on their own merits, and lenders can have very different ways of interpreting this data to each other.

The one thing that you definitely should not do is start making other applications elsewhere, at least until you understand the reason for your rejection. All applications show on your credit history, and multiple applications - and especially multiple rejected applications - will harm your credit score in and of themselves, which will only make you less likely to be approved in the future. If your credit score is the reason for the rejection, Experian has a guide on steps that you can take to improve it.

You can also look at alternative options. For example, if you can’t get approval for equipment financing, leasing or contract hire may be better options for your business.

It can all look a little daunting, but manageable debt is a key component of running any business and startup loans can be an accessible way of getting your business up and running and turbocharging it. You can turn your business dreams into your business reality by giving it the financial boost it needs!