Small business loans

What are my options? The essential guide to small business loans.

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Small business loans

Whether it’s for renovating offices, upgrading vital equipment, or just paying bills, a small business loan can give you the helping hand to get your business moving. With so many lenders and types of loan of offer, though, it can be hard to know where to start. Find out what questions you should be asking and how to compare your options with this guide.

What are small business loans?

A small business loan is an amount of money borrowed for business financing purposes – such as buying or upgrading equipment, securing new premises for your business, or even covering wages in a period of shortfall. Business loans are generally treated differently from personal loans by most financial institutions, and there are options open to businesses that aren’t available to individuals.

There are various types of loans a small business can take advantage of, and each has different strengths. There’s also a multitude of lenders to choose from, from major banks through to small online operators, and what they’re willing to offer will be different depending on your business.

A small business loan is made up of a number of different elements, and you’ll want to know about each of these before you apply for anything. Things to consider are:

Principal

This is the specific amount that you’re borrowing. The maximum you’ll be allowed to borrow will depend on the financial institution you’re going through, and the specifics of your business and how established it is.

Interest

The amount it’s going to cost you for the loan (as a percentage of what you borrow). Can be calculated in a number of ways – with fixed rate and variable rate being the most important options to consider. Again, the interest rate can vary greatly depending on your business and the lender in question.

Term

This is the amount of time it’s expected to take to pay off the loan, although this can obviously change due to early repayments and other factors. A shorter term generally means less overall interest, but repayments will be higher.

Repayment frequency

 This is how often you need to make repayments, and is often negotiable. Small business loans are generally paid off in regular instalments, where each repayment is the same amount.

Fees/charges

Loans will often have fees and charges over and above the interest charged on the loan. These can be initial set-up fees, or can occur with repayments or at certain time intervals. It’s worth doing your homework on these, as they can come as a surprise and add up to quite a lot of money.

What will affect my chances of getting a small business loan approved?

A key factor for small business loans is the risk involved – banks and financial institutions want to be confident that if they loan your business money, they can be sure of getting it back (with interest, of course). So, your chances of getting a loan and the amount you’ll be able to borrow will depend on how secure and well established your business is. When considering a loan application, a financial institution will pose the following questions:

  • How large and well established is your business, and what kind of sales or financial turnover is it seeing?
  • Is your business based on a niche industry or one with broad appeal?
  • Is your industry growing, or potentially under threat?
  •  What sort of customer base do you have, and is it growing?
  • Are you in a highly visible location, or in the public eye through some other means?
  • Is your business in a good position to be able to make your repayments?
  • Do you have other outstanding debts
  • What are you borrowing the money for – buying an asset, renovating your property, or just paying wages?

What types of small business loans can I choose from?

There are many options for loaning short-term funds for your business, and they each have advantages and disadvantages.

Loan Type
Unsecured business loans

This is similar to a traditional loan, but unlike many types of loan it doesn’t require any collateral – you don’t need to offer the lender a large asset (such as a property) as security. They tend to have shorter terms (1-3 years), as they're designed to be paid off sooner rather than later. You can’t borrow as much as you could with a secured loan and the interest rates are generally higher. But in Australia some unsecured loans can still offer up to $200,000 - $300,000, meaning this can be one of the best and most accessible options for a small business loan – especially for a start-up business .

Secured business Loan

This is what you might call a traditional business loan. It can offer larger amounts and better rates than an unsecured loan, but you’ll require a significant asset to offer as collateral – something like a property, which the bank can sell to cover their losses if things go wrong. That often puts these loans out of reach for many small businesses, which often don’t have an asset to offer. Some lenders can also have a minimum loan amount, which can be substantial.

Business credit card

This is one of the simplest and most flexible options for securing small amounts of short-term funding, but it comes at a cost. It's rather like getting a personal credit card – except with a few key differences, such as a higher credit limit (often around $50,000 mark). The liability is also generally tied to the business rather than to a specific person, which can be important if anything goes wrong. It's very flexible, and you only pay interest on the amount you've currently borrowed – repayable at any time. Some credit cards also offer features like zero repayments for the first 30 days – making it a very reasonable option for a short-term purchase to be paid off quickly. The catch is that after this period, interest rates are very high, making it an unsuitable option for anything more long term.

Line of credit

This is similar to a credit card. It involves a financial institution making an agreed amount of money available for your business to use at your discretion. They can offer larger amounts at better rates than a business credit card, but they're often more of a temporary measure – they can often have a time limit, or more restrictions around when you make repayments. You only pay interest on the money you’re currently using, although there may still be a maintenance fee if you haven’t withdrawn any funds.

Invoice finance

Invoice finance is an option for businesses with outstanding debts that are tying up their funds. In effect, this involves selling your outstanding invoices (the money other people currently owe to you) to a third party. They pay you a proportion of what the debt was worth (perhaps 70-80%), and then they take on the responsibility of collecting the debt themselves.

There's also a type of invoice finance called Recourse Factoring, which can offer a better return on the debt. But you retain some of the risk – you need to return the money if the debt isn’t repaid.

Merchant cash advance

This is different to a normal small business loan, as the financial institution advances you money and then takes its repayments as a percentage of your everyday profits. It means you pay the debt as you make money (rather than having an arbitrary repayment to make), but it tends to offer worse rates than a regular business loan. It's also generally only available to businesses with a steady cash turnover and a good track record, such as successful restaurants.

Also, the Australian government has far less regulation on these compared to other types of small business loans, so the lender’s terms and conditions can be a lot more restrictive – giving them some extra safeguards (which can vary between institutions).

Equipment finance

This is where a financial institution has put forward the funds to purchase a key piece of equipment, and you make payments to them to use it. Effectively it's like renting or leasing equipment, except you're paying a lender rather than a manufacturer or rental business. You never own the equipment though, and the bank can sell it if things go wrong.

Hire purchase

This is where a financial institution has put forward the funds to purchase a key piece of equipment, and you make payments to them to use it. Effectively it's like renting or leasing equipment, except you're paying a lender rather than a manufacturer or rental business. You never own the equipment though, and the bank can sell it if things go wrong.

Personal loans

In some cases, business owners will simply default to getting a personal loan to get funds for their business. You need to be careful though. As well as depending on your own credit rating and financial good standing (rather than that of your business), the liability for a personal loan falls on you.

How to maximise the chances of business loan approval

Know what type of loan you need

Knowing the type of loan best suited to your situation will make it easier to ask the right people the right questions.

Keep good records

This will make it far easier to show a potential lender that your business is ticking along nicely.

Maintain good credit

A healthy credit record shows lenders that you have a proven history of paying your debts on time.

Have evidence of a steady cash flow

Being able to show lenders that your income is steady and sufficient for your expenses lets lenders know you’re able to make repayments.

Remember every lender is different

If one lender turns you down, that shouldn’t be the end of the story. Don’t be afraid to ask around.

Frequently Asked Questions about small business loans

How hard is it to get approved for a small business loan?

Financial institutions examine your business when considering a loan application, so your chances of getting a loan often come down to how successful your business is and how stable its finances are. If your business is not in a strong situation, it’s worth remembering that different lenders have different approaches to risk, so you might have a better shot with someone other than the big banks. It’s also worth remembering that the bigger the loan, the bigger the risk – so borrowing a smaller amount can make things easier.

Am I better off going with a bank or a different financial institution?

If you’re going for a secured loan, banks can sometimes offer better rates than some of the other financial institutions (such as online lenders) – although they’ll generally be more risk averse, and do more rigorous checks on your business and its finances. Banks don’t like taking chances. For an unsecured loan however, generally the rates are pretty similar – meaning the faster turnaround and easier application processes of many smaller operators can make them a pretty good option. But it’s always worth doing your homework and comparing what’s on offer.

Do I need a good credit score to get a small business loan?

No. Although it’s true that most lenders will check your credit history and may not loan to a customer with bad credit history, it doesn’t completely count you out of getting a small business loan. In this situation, you’ll probably be looking for what’s called a “bad credit” business loan – which is a type of loan tailored for businesses with a poor credit history. These are typically offered by smaller specialist lenders.

What size deposit do I need for my small business loan?

You don’t generally require a deposit for a business loan. Some lenders have an upfront fee that could be either a set amount, or a percentage of the amount borrowed (2-3% of the loan amount is common), but many don’t. A secured loan will require an asset (such as a property) offered as collateral in exchange for better rates and larger loan amounts, but as long as you’re able to repay the loan, you won’t lose your asset.

What amount will I be able to borrow on my small business loan?

Amounts vary from lender to lender, and will change depending on the credit history and financial situation of your business. In Australia, many lenders are willing to offer between $5000 and $300,000 for an unsecured small business loan, while some can offer considerably higher figures (into the millions). Figures that large may not be available for newer businesses with less of a financial track record though – or the lender may require some security or collateral on the loan.

How long does it take to get a small business loan?

This varies massively from lender to lender, and can be affected by how much you’re borrowing and other factors. Some lenders may be willing to grant approval for a loan within 24 hours. A large bank looking at a $300,000 loan might be a lot more cautious, and the process could take many weeks. Shop around, but remember that the easier options often mean more risk for the lender, which often means higher rates.