What Is a Business Loan and How Does It Work? | Adelpha Capital
Updated: Aug 12
A business loan is a form of finance designed to provide a business with capital that it repays over an agreed period, usually with interest.
Businesses use loans for many reasons. You might need additional working capital, want to purchase equipment, invest in growth, recruit staff, refurbish premises or simply need funding to manage the timing difference between money coming into and going out of your business.
Although the basic concept is straightforward, business loans come in many different forms and lenders can assess applications very differently.
Understanding how the process works can help you decide whether a business loan is appropriate for your company and what to expect when you apply.
How does a business loan work?
With a typical business loan, a lender agrees to advance your business a specified amount of money. The business then repays the borrowing, together with the agreed interest and any applicable fees.
For example, a business might borrow £30,000 and repay the loan over 24 months.
The exact structure depends on the lender and product. Repayments might be made monthly, weekly or according to another agreed schedule.
Before accepting a loan, you should understand:
how much you are borrowing;
the interest rate and any fees;
how frequently repayments are made;
the length of the loan;
the total amount repayable;
whether there are early repayment charges or minimum interest requirements; and
whether any security or personal guarantee is required.
The repayment amount matters, but so does the overall structure of the facility. A shorter loan may be repaid more quickly but can place greater pressure on monthly cash flow.
What can a business loan be used for?
Business loans can be used for a wide range of legitimate business purposes.
Common examples include working capital, purchasing stock, equipment, refurbishment, marketing, recruitment and expansion.
A company may also use borrowing to deal with a temporary cash-flow requirement. A profitable business can still experience periods where cash coming into the business doesn't coincide with its expenditure.
For example, a company might have won a large new contract but need to pay suppliers and employees before receiving payment from its customer.
The important question isn't simply whether the business needs money. A lender will normally want to understand why the funding is required and how taking on the additional borrowing fits with the company's financial position.
What types of business loans are available?
There are many forms of business finance. Some of the most common include:
Unsecured business loans
An unsecured business loan does not require the business to provide a specific asset, such as a property, as security for the loan.
That doesn't necessarily mean there is no security at all. A lender may require one or more directors or shareholders to provide a personal guarantee.
Unsecured loans can often be arranged relatively quickly because there is no requirement to value and take security over a particular asset.
Secured business loans
A secured business loan involves the lender taking security over an asset.
Depending on the facility, this could include property or other business assets.
Security can sometimes allow a lender to consider a larger loan, a longer repayment period or an application that wouldn't meet its criteria on an unsecured basis.
Revolving credit facilities
Rather than receiving one fixed advance, a revolving facility gives a business access to an agreed credit limit.
The business can draw funds when required, subject to the terms of the facility.
This can be useful where working-capital requirements fluctuate rather than arising as a single one-off expense.
Short-term business loans
Some businesses require funding for months rather than years.
A short-term loan can be useful where there is a clearly identifiable short-term requirement and the business has sufficient cash flow to support the higher repayments associated with repaying the borrowing quickly.
There isn't one type of business loan that's appropriate for every company. The right structure depends on the purpose of the borrowing, the company's financial position and its ability to service the repayments.
How much can a business borrow?
There isn't a single formula that determines how much a business can borrow.
Lenders may consider factors including:
Turnover. The scale and consistency of revenue can provide an indication of the size of facility a business may be capable of supporting.
Cash flow. A lender needs to be comfortable that the company can meet the proposed repayments alongside its existing commitments.
Existing borrowing. Other loans and finance commitments affect both affordability and the company's overall indebtedness.
Trading history. An established business with a demonstrated trading record will generally provide a lender with more information on which to base its assessment.
Credit history. The credit profile of the company and, in some cases, its directors can influence a lending decision.
Recent bank conduct. Bank statements or open-banking information can help a lender understand how the company is currently performing rather than relying solely on historical accounts.
Security. For secured lending, the nature and value of the available security will also be relevant.
Two businesses with identical turnover can therefore have very different borrowing capacities.
We'll look at this in more detail in our guide to How Much Can My Business Borrow?
What do lenders look at when you apply for a business loan?
Business lenders typically want to answer two fundamental questions:
Can the business afford the borrowing?
and
What is the risk that the lender won't be repaid?
To answer those questions, lenders can consider information from several sources.
This might include filed accounts, management accounts, business bank statements, open-banking data, credit searches and details of existing borrowing.
A lender may also want to understand recent developments in the business.
Accounts are inherently historical. If a company's most recent accounts cover a financial year that ended nine months ago, quite a lot could have changed since then.
That's one reason why recent bank conduct and current trading performance can be particularly important when assessing an SME loan application.
Do you need to be profitable to get a business loan?
Not necessarily.
Profitability is important, but it is only one part of a lender's assessment.
A business may have made an accounting loss while still generating sufficient cash to service borrowing. Equally, a company showing an accounting profit can experience serious cash-flow problems.
Lenders will normally consider the reason for any losses, whether they are continuing and what the company's more recent performance looks like.
A business that has experienced a temporary setback is different from one suffering sustained deterioration with no clear route to recovery.
Do you need a personal guarantee?
Many SME lenders require personal guarantees, particularly for unsecured lending to limited companies.
A personal guarantee is a legal commitment from an individual—usually a director or shareholder—to repay the lender if the company fails to meet its obligations.
It is therefore a significant commitment and shouldn't be treated as a formality.
Whether a guarantee is required will depend on the lender, the type and size of facility and the circumstances of the application.
We'll cover this separately in What Is a Personal Guarantee on a Business Loan?
How quickly can you get a business loan?
Timescales vary considerably.
Straightforward unsecured applications can potentially progress quickly where the lender receives all the information it needs and is comfortable with the application.
More complex facilities can take longer, particularly where property or other assets are being taken as security and legal work is required.
One of the easiest ways to avoid unnecessary delays is to provide complete and accurate information at the beginning of the application.
Is a business loan right for your company?
Borrowing can be valuable when it enables a business to do something that produces a commercial benefit.
The more useful question is therefore often not “Can we borrow?” but “Does borrowing make commercial sense?”
Funding £50,000 of stock that can be sold profitably may make sense. Taking expensive short-term borrowing simply to postpone an underlying cash-flow problem may not.
Before borrowing, consider the purpose of the loan, expected benefit, repayment burden and what happens if the anticipated benefit takes longer to materialise than expected.
Applying for a business loan with Adelpha Capital
Adelpha Capital provides business finance to established UK SMEs.
We assess applications individually rather than relying solely on an automated credit score.
We look at the wider financial position of the business, including its trading history, recent performance, cash flow and existing commitments.
If you're considering business finance, you can apply online or speak to the Adelpha Capital team about your requirements.