Small Business Commercial Loans Guide

Explore the commercial loans options available to your business, how commercial finance brokers may help and how to find the best rates.

What is a commercial loan?

A commercial loan is a way of describing any arrangement between a lender and a business. For instance, when a business applies to a High Street bank for short or long-term finance, this is regarded as a type of commercial loan.

Benefits of using a commercial loan?

If your business needs money, a commercial loan can be a great option. Commercial finance is big business. Whether it’s to buy a vehicle for the business, hire staff,  build a new facility or make use of a commercial property loan in order to open a new location, commercial loans provide businesses with the funds needed to build for the future.

Because commercial funding sources will be lending money to the business, you will likely to be able to borrow a larger amount than you would qualify for as an individual. And you can use the assets of the business as security, if needed.

How do commercial loans work?

If you do go for commercial lending, you will need to pay back the loan plus interest.  Whether that loan comes from a bank, an alternative business finance provider or the government, that lender will want to see proof that your business will be able to make its payments.

To increase your chance of getting a commercial loan, prepare supporting documents for your application. Your financial statements, profit and loss, valuation of any assets you may need to use as security, and your business plan will all help.

What are the costs of commercial loans?

Commercial lending rates vary. For smaller loans, the lender may offer a fixed rate to all borrowers that qualify. For larger loans (usually £100,000 or above), the lender may negotiate the interest rate on a loan-by-loan basis.

You may be offered a variable rate in some circumstances. This means your repayment amount will be less predictable, but it may be lower than if you take a fixed rate.

Be aware that a short-term commercial loan – usually one to three years in length – will often have a higher interest rate than a long-term loan as the lender must charge a higher rate to ensure it makes a profit. Longer loans, which can be for five, ten, 20 years or longer, usually offer a lower rate.

To get an idea of the cost of various commercial loans, check advertised representative APRs (annual percentage rates). Then use a commercial loan calculator to experiment with different combinations of loan amount, interest rate and length of term, to determine what works best for you. Commercial loan repayment calculators are available online.

Commercial finance brokers are another option to help you get a deal that suits you. These third parties try to bring together lenders and borrowers. As they have dealt with many lenders, they can help you quickly get an understanding of the marketplace. They typically charge a fee for their services. Check how much they will charge – flat fee, percentage of loan, only if your loan is approved – beforehand. Their fee may be worthwhile if they get you a better deal.

How long does it take to secure a commercial loan?

A small, unsecured commercial loan for a business with good history, complete financial documents to support the application and creditworthy directors may be approved in a matter of hours or a couple of days.

For a larger commercial loan, your application may take a few weeks or even a few months, depending upon the amount borrowed and the length of the term. For a loan with a very long term, the lender may wish to perform extensive examination of your financial records to confirm the financial viability of the business over the term of the loan. These types of loans will almost always require security as well.

What type of security do I need for commercial loans?

Unsecured commercial loans may be available for smaller amounts (usually below £25,000) taken for shorter terms (usually one to five years). When the loan amount or term is more than that, some type of security is usually required.

The most common things offered as security are vehicles, property (either the business premises or a director’s personal property) and shares. Traditional lenders may only accept these types of security. However, specialist commercial finance companies may offer other options as security, such as your receivables, mezzanine finance options or anything else agreeable to both parties.

For businesses that are fundamentally sound but lacking sufficient security, the Enterprise Finance Guarantee scheme will provide security for 75 per cent of the loan amount to qualifying SMEs. In addition to paying back the loan, the business must also pay a quarterly fee (currently two per cent per annum) on the outstanding balance as a premium for making use of the scheme.

How to avoid funding your business from personal assets

Commercial loans will generally be used by a business to fund a particular project, development or acquisition. However, many businesses will also use this type of funding for their day-to-day costs, to avoid funding the business from their personal assets.

A commercial loan is a very cost-effective way for a business to access funds when other, more sophisticated, methods are not available, such as going to the bond market or selling equity in their business. With a commercial loan you don’t give up a share of your business. However, you may have to pledge security over your assets to secure the lending.

Why commercial loan flexibility is good for a growing business

If a business has a good credit history and a record of repaying their previous borrowing, there is little reason why a business shouldn’t access commercial credit for many reasons. The flexibility of this type of lending is suitable for an expanding business, offering the potential to increase when the business requires further access to funds.

For seasonal or other cyclical business types, a commercial loan can also be useful to cover day-to-day costs such as payroll and other operating expenses. In some cases, a lender will review the business’s past history and suggest flexible commercial terms that can be used as and when the business needs the funds. This can really help with planning and budgeting small business finances.

Why lenders have their own preferred type of security

Most commercial loans do require the borrower to have some form of security. This could be a valuable asset, something the lender could claim in the event of the borrower failing to repay their debt.

However, lenders often have their own preferred type of security e.g. Merchant Cash Advance lenders will accept repayment of their commercial loan from the till receipts taken each time a purchase is made. This can be beneficial to the borrower as it means that repayments are aligned to their takings and not to a set amount being deducted from their account each month.

Some lenders will accept the repayment of the interest only on a commercial loan and expect the capital to be repaid at the end of the loan agreement. This might be a suitable arrangement where a property or some other large capital project is to be delivered in a known timescale and the borrower has the advantage of smaller monthly payments during the life of the loan.

Another popular form of commercial loan is a renewable or roll-over loan. This type of borrowing can also be very flexible and attractive. When a business needs to make sporadic, large payments for their inventory, this might be a good solution as it allows the lender and borrower to agree in advance that there may be situations where a loan is renewed rather than repaid. Large businesses find this type of borrowing useful.

How does a commercial loan compare to other forms of borrowing?

There is little difference in obtaining a commercial loan from many other forms of borrowing. Lenders will expect to review bank account history for at least three months. They will also look at the history of borrowing and, of course, that a business has a good record in repaying these debts.

Once the lender has reviewed the documentation they need to make a lending decision, they will calculate how much interest to charge based on the level of risk they think there is in making the commercial loan.

There can be occasions where a lender will also require other forms of security before entering into a loan agreement. This might be in the form of added insurance to protect against default in the event of a disaster striking the business.

Useful links

Commercial loans: Funding the future growth of your business