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Growing a business requires capital investment. No matter the central focus to your business, and the sector it is in, this one fact remains true. Capital represents many things, from the obvious ability to employ additional staff, find suitable premises, or upgrade equipment to the more abstract, like freeing up your time to focus on client acquisition or product development.
Finding the right source for capital investment is important. Simply jumping at the first offer for money that is available is a desperate move that can lead to a limited future situation, and what’s right for one business model isn’t necessarily good for another.
Getting investment from a third party typically involves giving up a portion of your control and (potential) future profits – off putting for many. If you want to keep complete control over your business, at some point you may need to consider a business loan.
Is taking out a loan the right thing to do? What is the right time to do so? What products are potentially available to you? These are just a few of the key questions. Whilst this is a fast-evolving sector, the points highlighted below are general trends at the time of writing and of course subject to regular change.
Types of business loans
When we think of a loan, it’s normally a cash injection from a bank or similar organisation that must be repaid with interest on a monthly basis. That is, indeed, one of the options available. However, a standard unsecured loan is only one type of finance option available to businesses in the UK, and there are many other products that may suit your needs better.
What is asset finance?
Whether you think you have or not, the chances are that asset finance is something you may already be using. Car leasing and even a standard mobile phone contract are both types of asset finance that are used by the public across the country, but there’s a lot more choice and a far wider range of applications than you may think.
Leasing
Leasing is a standard type of asset finance and can typically be thought of as a long-term hire arrangement. When you lease, you do not own the asset, but agree to make monthly payments for a set term, returning the asset at the end.
The monthly leasing payment is often little more than the cost of depreciation on the asset with a fee on top for the leasing company’s administration and profit. When the contract term is over, the asset is sold at market value, making sure the leasing company do not lose money. For this reason, damage done to the asset during the lease is typically passed on to you as an extra penalty at the end.
Car leasing is the best known form of asset leasing, but almost every business need is covered through this form of finance. It can include:
Technology leasing
Laptops, desktop computers, tablets and network infrastructure are all available from asset lease companies. Having the capital to invest in a new laptop might be a stretch for many small businesses, but a £20 per month outgoing is a lot easier to budget for.
IT leasing also includes subscription to cloud-based services, so if you have a professional Dropbox account, you are already using IT asset finance!
Office furniture leasing
Fitting out a new office with desks and chairs can be a huge outlay, so it makes sense that leasing companies exist who are willing to turn a capital outlay into a spread monthly payment.
Construction equipment leasing
It is rare for a small building firm to own their own diggers or cranes. This specialised and expensive equipment is more often leased.
Vehicle leasing
A company van for a tradesman, or company car for client management – these are typical uses for vehicle leasing, and many companies, including the dealerships themselves, have leasing as an option.
Specialised equipment leasing
Dedicated asset finance companies exist who will be willing to outlay the capital for equipment that is very specialised to your specific sector or business and then lease it to you under contract. This can be especially useful if you have a fixed project that requires an expensive piece of equipment that you would not use elsewhere, allowing you to undertake the project without a major (and potentially wasteful) capital investment.
Premises leasing
Renting an office or warehouse space is a well-known form of asset leasing, essential for most businesses who cannot afford (nor want) a commercial mortgage.
Short-term leasing
Most leasing is measured in years, with three years a standard length for a lease contract, however, short-term leasing is also available. Typically, this is more expensive per month, but allows you to take on a lease for as little as three months.
Secured loans
A secured loan is another type of asset finance. Here the intention is for you to own the asset permanently, and so a loan is taken out using the asset as security. Secured loans like this include mortgages (the asset is the property), and a car hire purchase agreement (the asset is the vehicle).
With the right specialist lender, it is possible to obtain a secured loan against many different types of asset, from industrial equipment through to technology.
A secured loan is considered a lower risk loan for the lender, and so it is often favourable in terms of interest rates but it is important to understand that defaulting on a secured loan will ultimately result in repossession of the asset and often additional costs (especially if the asset has depreciated significantly in the interim).
Secured loans can be quite large, often representing a large portion of the asset value. Loan-to-value ratios as high as 90% can be found, especially with commercial mortgages and car finance.
Many secured loans are structured with a large initial payment (often called the deposit), and a large final payment (the balloon payment) in order to keep the monthly repayment level low. Loan terms often stretch for many years, relative to the size of the borrowing, and fluctuating interest rates can affect the monthly repayment. Examples include:
- A standard repayment mortgage – variable deposit, relatively low monthly payment often affected by changing interest rates, very long term, no balloon payment.
- An interest-only mortgage – large deposit, low monthly payment affected by interest rates, long term, very large balloon payment.
- Car finance hire purchase – small deposit, low set monthly payment unaffected by interest rates, medium term, moderate balloon payment.
- Specialised equipment secured loan – moderate deposit, low set monthly payment unaffected by interest rates, short term, moderate balloon payment.
Secured loans are often flexible in that they can be repaid early or renegotiated towards the end of term in order to extend the length of the loan. In some cases (such as a mortgage), refinancing to release equity in the asset is also possible.
One type of secured loan familiar to most is a mobile phone contract that includes a handset, which is very similar to a hire purchase agreement.
Bridging loans
Bridging loans are very short term, high interest loans that are available to businesses looking to make a major purchase at short notice while securing other financing. While it is possible to consider bridging loans with a very negative view, used properly they form an important part of many business strategies.
A bridging loan is a form of secured loan that is intended to be replaced with lower interest, responsible financing as soon as that is available. This exit strategy forms a key part to the loan itself and without a suitable level of replacement finance being planned for, the bridging loan itself will be rejected.
Bridging loans tend to have interest leveraged on a daily basis, and are typically represented with a monthly, rather than annual, interest rate.
Many bridging loans are used to purchase property, with a mortgage representing the exit strategy. As a mortgage can take months to put in place, use of a bridging loan allows for immediate purchasing. Mortgages also have more specific criteria that may be difficult to meet on the purchase date, but able to be fully considered some months later.
As an example, take a run-down property that is available at auction for a low price, making it a good investment. Auctioned properties must be paid for in full within 28 days; often too short for a mortgage to be finalised. Additionally, the mortgage criteria will reject a building that is unsuitable for habitation. A bridging loan can be obtained quickly (often within 48 hours) and so can form a central part of the strategy.
In this case, the property is purchased at auction and a bridging loan is taken out that will pay both for its asking price, and the cost of renovations. Three months of work is undertaken to bring the property up to specification and then a mortgage is applied for to pay off the bridging loan. With the property now a suitable asset for the mortgage lender, and its market value many times that of its original cost, the mortgage is easily agreed. The paperwork takes two months to complete and at five months after the original purchase, the bridging loan is paid off with interest and the property secured with a standard mortgage.
Bridging loans are not just for property purchases however; they are also suitable for raising capital for a high-value business project, for example, allowing the employment of additional staff and covering other short term costs before the project can be invoiced (at which point the bridging loan is paid off in full).
What is an unsecured loan?
An unsecured loan is a much higher risk for a lender and in order to make sure that your business represents a reasonable investment, a lot will depend on the checks the lender can make regarding the business credit history and viability.
Lenders offering unsecured loans to businesses will look at the following:
- The businesses credit history;
- The personal credit report of the directors (if limited company) or you (if sole trader);
- The business plan; and/or
- Recent business accounts.
Negative credit history, such as CCJs or an previous insolvency, can heavily impact your ability to obtain an unsecured loan.
Unsecured loans can be used for any business activity, from purchasing new equipment through to getting new staff – it is literally money loaned to you for your use as you see fit. However, if you have obtained a loan through a business plan proposal explaining how you intend to invest the capital, then it would be irresponsible for you to use it in other ways and could harm any future application for credit if misused.
Bank loans
Going to your bank to obtain a loan is a traditional way to finance your business investment. If you have a good history with your bank and a strong credit record, then often the bank does represent a good choice, although you should always look at other options on the market to see if you can secure a better rate.
Peer-to-peer lending
Growing in the marketplace, peer-to-peer loans represent a system whereby a group of anonymous investors provide loans to businesses at more competitive rates than traditional lenders. Peer-to-peer (P2P) loans are online-only systems that have their own risk assessment criteria to banks, with quick decision making and potentially more-suitable products for your business.
Once secured, a P2P loan works in a standard fashion, with interest accrued and monthly repayments made until the loan is repaid in full.
Challenger bank loans
The rise of internet-only ‘challenger’ banks means there are more loan options in the business marketplace than ever before. Many challenger banks have a range of extra incentives to make their loans incredible competitive and worth looking at. Even if you don’t regularly bank with them, these loans are open for your application and, once using their service, you may find yourself wanting to switch over to them for all your business banking!
Credit cards
Business credit cards represent another way to obtain short-notice finance. Applied for in a similar way to any personal credit card, or unsecured loan, credit cards typically use similar criteria to a bank loan regarding assessing your suitability as a borrower.
Unlike a loan however, a credit card represents an ongoing line of credit, meaning that once you have repaid it, you can reuse the credit stream without reapplying. This can be incredibly useful for businesses, meaning there’s some short-term borrowing available for future use with no need to worry about application or waiting.
Paying back a credit card in full is an important aspect of usage, however, as failure to do so will result in high interest charges and damage to your future credit score.
Credit cards represent an excellent backup system for business capital flexibility but are rarely the right choice for long-term investment.
Overdraft facilities
Like a credit card, an overdraft facility represents ongoing credit that can help you through difficult periods of business but shouldn’t be considered a long-term solution to any capital investment problems. Overdraft usage isn’t a positive influence on your credit card and is subject to both high levels of interest and additional fees.
Having an overdraft facility, even if unused, can provide a level of mental security in case of any sudden need that helps you concentrate on your business rather than worrying about day-to-day cashflow.
Newer business-specific options
Finance companies offer a range of additional products aimed at businesses, many of which represent slightly different interpretations on the above products, but a few of which are genuinely useful ways for a business to obtain finance.
Invoice loans
An invoice-based loan is a product available for businesses who have small to medium cashflow issues, typically due to expansion.
With an invoice loan, the lender will make a cash sum available to a business based on work that has already been invoiced but not yet paid by the client. Upon payment, the loan, fees and interest are repaid. Essentially, the system is designed to facilitate the effective immediate payment of invoices and is especially useful when clients have 30, 60 or even 90-day invoice payment terms.
Invoice loans require an extra level of credit checking – namely that of the end client who will be paying the invoice. Lenders will be keen to see previous invoices paid by the same client without a problem and will perform a soft credit search on the client. AKA a smart search, the search it leaves on your credit file cannot be seen by other lenders so won’t affect your credit score or affect a potential lender’s decision if another search is done at a later date.
Obviously, the size of the invoice loan is dependent on the amounts invoiced, with many loans at the 60% LTV (loan-to-value) ratio. Thus, an invoice of £10,000 would be likely to raise £6,000 cash in advance.
Merchant cash advance
Relatively new to the finance world, a merchant cash advance represents a loan offered to businesses that make a large number of small payment transactions (such as shops or online stores). The loans are repaid by the lender taking a percentage of all payments made until the loan is settled.
This type of loan is especially useful for businesses with fluctuating income, as during a good period, more of the loan will be repaid, but there is no pressure in more difficult times to meet a set monthly repayment.
The size of merchant cash advance loans is limited to the monthly turnover of the business, and you will need to show complete accounting records to the lender to secure the loan.
Business cash advance
Like a merchant cash advance, a business cash advance is a loan with a flexible repayment method which is based on the business income each month. Rather than a set sum to be budgeted for, business cash advance loans are paid back as a percentage of monthly turnover. This has the effect of stress-free borrowing during quieter months and requiring larger repayments during busier months and is often an excellent choice for smaller, growing businesses.
Again, you will be expected to provide full accounts and the loan size will be relative to historically proven turnover.
Update – Coronavirus crisis
During the Coronavirus crisis, three specific schemes have been set up to support businesses through the British Business Bank:
- Coronavirus Bounce Back Loan Scheme (CBBLS): available from May 2020 Small businesses are to have access to loans up to £50,000, 100% backed by the Government, by filling out a simple two-page self-certification form online:
- Coronavirus Business Interruption Loan Scheme (CBILS): Offering SMEs loans up to £5m, interest-free up to 12 months and personal guarantee free for up to £250,000; and
- Coronavirus Large Business Interruption Loan Scheme (CLBILS): ensures that more firms are able to benefit from government-backed support during this difficult time. It provides a government guarantee of 80% to enable banks to make loans of up to £50 million to firms with an annual turnover above £45 million.
The structure and term of each of these loans vary, so we hope this article could be some help in trying to understand what is best for your business to survive the current crisis, then thrive afterwards.
In addition to this, there is a lot of concession measures to support individuals and their businesses, including payment holidays or deferrals in payment on mortgages, loans, store cards and credit cards as well as reduced rates and greater flexibility on overdrafts. If you are not already being offered these by you existing lender, we suggest that you request it from them, or consider switching your services for improved terms, if possible.
Help from Black and White Accounting
Taking out a loan is a serious consideration. While it can provide a cash injection when you need it, the repayments can have a significant impact on your monthly finances for many months to come. With all the options available, however, it is likely that if you are looking to improve your current capital without diluting your level of control over your business, that a specialised loan provides everything you need.
At Black & White Accounting not only do we work closely with our clients, but we also work closely with a number of brokers and lenders, so are uniquely positioned to help match-make you and the right loan product, if indeed loan financing is the best thing for you.
We can provide the lenders with any required financial information and assurances to support your application, all of which will increase the chances of you getting the right product at the most competitive price. We can go through the pros and cons of the different options which are available to you, so you are comfortable with what you decide. Email us, complete the ‘Got a Question’ form on the right hand side, or call us today on 0800 140 4644. We look forward to talking further with you.
