Bank finance

Whether you are starting or expanding a business, you may need to seek financial help from an external source.

Banks offer short- and long-term debt finance via loans and overdrafts as well as other types of finance. These are available by application to any high street bank, usually involving a quick decision process.

This guide looks at the different types of bank financing available to businesses, and the advantages and disadvantages of borrowing from a bank. It provides guidance on loans and overdrafts and how to choose a bank and finance option that is best for you. You will also find details on credit scoring, loan guarantees and security, and European Investment Bank funding.

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Types of bank finance for businesses

There are several types of bank finance available to your business, with different packages available to suit your needs as your business requirements change. The type of finance that would best suit your business may be based on the purpose of the finance, how quickly you need finance, and how quickly you could repay it.

Short-term finance

Overdrafts are used in conjunction with business bank accounts and are a flexible source of working capital for short-term needs. For more information, see the page in this guide on overdrafts.

Bridging finance is provided by the bank to businesses to maintain cashflow while awaiting funds from grant cheques, drawdown of commercial mortgages or loan agreements, or other confirmed sources of future income.

Working capital funding

Invoice finance offers ways to access working capital by unlocking the value of invoices, although interest rates and charges apply on the cash advanced. Invoice discounting allows you to draw on funding secured against approved invoices, while in factoring you can sell invoices to your financier. If your buyer introduces a supplier finance scheme (also known as supply chain finance or reverse factoring), this will provide the same benefits at a potentially much lower cost.

See our guide on factoring and invoice discounting: the basics.

Medium-term finance

Term loans have a fixed or variable interest rate and mature over a one- to seven-year period. They are typically used to buy fixed assets such as property or machinery or other purchases of a capital nature. For more information, see the page in this guide on loans.

Asset finance and leasing options allow businesses to spread the ownership associated with buying assets. When you buy assets through leasing finance, the leasing bank buys the equipment for you to use, in exchange for regular payments. Leasing or hire purchase can help you maintain cashflow and allow greater flexibility in upgrading equipment.

For more information, see our guide on how to decide whether to lease or buy assets.

Long-term finance

Commercial mortgages are provided by banks to finance the purchase of business premises. Types of mortgage available include repayment, commercial endowment or pension. The mortgage will usually be repayable over a 15-year period.

You can get advice on the best providers of commercial mortgages from your bank’s business adviser or a commercial mortgage broker. For more information, see our guide on commercial mortgages and lenders.

Search for specialist commercial finance brokers on the National Association of Commercial Finance Brokers website- Opens in a new window or call the NACFB Enquiry on Tel 01392 440 040.

Fixed asset loans are loans for assets that cannot easily be turned into cash – eg property, plant or machinery. The loans can be fixed for up to ten years. With this type of loan, the asset itself is the collateral and can be repossessed if you do not maintain repayments. For more information, see our guide on how to decide whether to lease or buy assets.

Banks may also provide a range of specialist services to fund expansions, mergers or acquisitions. For more information, see our guide on how to raise long-term funding through debt capital markets.

However, there may be situations when you are unable to obtain finance from a bank. If this is the case, there are other finance options available to you – see our guide on non-bank finance.

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Loans

A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.

Loans are generally most suitable for:

• paying for assets – eg vehicles and computers
• start-up capital
• instances where the amount of money you need is not going to change

The terms and price of loans will vary between providers and will reflect the risk and cost to the bank in providing the finance. For larger sums, the pricing and terms may be negotiable.

Banks will loan money to businesses on the basis of an adequate return for their investment, to reflect the risks of defaulting and to cover administrative costs. If you have an established relationship with your bank, they will have developed a good understanding of your business. This will help them to advise you about the best product for your financial needs.

Different types of bank loan include:

• working capital loans – for short notice or emergency situations
• fixed asset loans – for buying assets where the asset itself is collateral
• factoring loans – loans based on money owed to your business by customers
• hire purchase loans – for long-term purchase of assets such as vehicles or machinery

Advantages of term loans

• The loan is not repayable on demand and so available for the term of the loan – generally three to ten years – unless you breach the loan conditions.
• Loans can be tied to the lifetime of the equipment or other assets you’re borrowing the money to pay for.
• At the beginning of the term of the loan you may be able to negotiate a repayment holiday, meaning that you only pay interest for a certain amount of time while repayments on the capital are frozen.
• While you must pay interest on your loan, you do not have to give the lender a percentage of your profits or a share in your company.
• Interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan.
• There may be an arrangement fee that is paid at the start of the loan but not throughout its life. If it is an on-demand loan, an annual renewal fee may be payable.

Disadvantages of loans

• Larger loans will have certain terms and conditions or covenants that you must adhere to, such as the provision of quarterly management information.
• Loans are not very flexible – you could be paying interest on funds you’re not using.
• You could have trouble making monthly repayments if your customers don’t pay you promptly, causing cashflow problems.
• In some cases, loans are secured against the assets of the business or your personal possessions, eg your home. The interest rates for secured loans may be lower than for unsecured ones, but your assets or home could be at risk if you cannot make the repayments.
• There may be a charge if you want to repay the loan before the end of the loan term, particularly if the interest rate on the loan is fixed.

When loans are not suitable

It is not a good idea to take out a loan for ongoing expenses, as it may be difficult to keep up repayments. Ongoing expenses are instead best funded from cash received from sales, possibly with an overdraft as backup. For more information, see the page in this guide on overdrafts.

If you cannot obtain a loan or other type of finance from your bank, there are other finance options available to you. For more information, see our guide on non-bank finance.

If you believe that a bank loan may be a viable option for your business, see the page on preparing for a loan or overdraft in our guide on obtaining bank financing.

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Overdrafts

An overdraft is a borrowing facility attached to your bank account, set at an agreed limit. It can be drawn on at any time and is most useful for your day-to-day expenses as it can help you to manage your cashflow more flexibly.

It is worth noting that loans are probably more appropriate for long-term funding. An overdraft is likely to cost more than a loan for a long-term purchase.

Advantages of an overdraft

• An overdraft is flexible – you only borrow what you need at the time which may make it cheaper than a loan.
• It’s quick to arrange.
• There is not normally a charge for paying off the overdraft earlier than expected.

Disadvantages of an overdraft

• If you have to extend your overdraft, you usually have to pay an arrangement fee.
• Your bank could charge you if you exceed your overdraft limit without authorisation.
• The bank has the right to ask for repayment of your overdraft amount at any time, although this is unlikely to happen unless you get into financial difficulties.
• Overdrafts may be secured against business assets.
• Unlike loans you can only get an overdraft from the bank where you maintain your current account. In order to get an overdraft elsewhere you need to transfer your business bank account.
• The interest rate applied is nearly always variable, making it difficult to accurately calculate your borrowing costs.
• Unutilised overdraft facilities may be reduced by the banks at short notice, although this is unlikely to happen unless you get into financial difficulties.

Bear in mind that what starts out as a good deal may change – as may your business needs. It’s worth reviewing your options regularly.

If you believe that getting an overdraft may be a viable option for your business, see the page on preparing for a loan or overdraft in our guide on obtaining bank financing.

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Where to look for a bank loan

Banks are the main source of small business loans, but many other organisations provide loans at competitive rates. Building societies offer business mortgages and personal loans. You can also consider finance from a non-bank lender. See our guide on non-bank finance.

Being ready and meeting lender requirements

Before you look for a financial provider, you should ensure that your business is able to meet the requirements of potential lenders and secure a deal that will benefit your business.

One way to make sure your business is prepared is to ensure your business plan is up to date, and that you are well informed about your own finances. For example, you should be able to discuss:

• your audited accounts for the past two years
• evidence of your current performance
• a profit-and-loss forecast for next year
• business bank statements for the past six months
• profiles of each partner or director in your business

You will also need to be clear about the amount of money you require and what it will be used for.

For more information, see our guides on obtaining bank financing and cashflow management: the basics.

It is also important that your business and personal credit ratings are up to date and as free from errors as possible. You can improve your credit rating by ensuring that you:

• pay your suppliers regularly
• capitalise the business by investing your own funds, in the form of loans fixed against assets the business owns – eg stock, premises, vehicles
• maintain a regular profit in the business, rather than taking too much out

For more information on preparing to apply for a loan, see our guides on how to use your business plan to get funding and obtaining bank financing.

Getting the best loan deal

You should take care to choose the right loan option that best suits your business needs. For more information, see the page in this guide on types of bank finance for businesses.

After you have chosen the type of loan that best suits your business needs, you should also try to get the best deal available. To ensure this, you should:

• Shop around – compare interest rates and negotiate to get the best deal, and ask for any special terms in writing. You can also use the Business Account finder service on the British Bankers’ Association (BBA) website- Opens in a new window.
• Use a finance broker – this can save you time and increase your chances by presenting your proposal efficiently to appropriate lenders. Find a financial broker on the National Association of Commercial Financial Brokers (NACFB) website- Opens in a new window.
• Research the small print – assess all lending criteria, such as interest rates, loan terms and set-up fees, plus special deals for start-ups. Consider having an expert, such as a solicitor, review the loan documents.
• Compare loans between different banks and be prepared to switch providers.

For more information, see the page in this guide on loans.

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Choosing the right bank

When choosing which bank to set up a business account with, it’s a good idea to compare at least two before making a decision. You should consider the various services, fees and facilities that are on offer to enable you to find the best bank for your type of business.

When comparing banks, you should think about:

• whether the bank has a dedicated small business team
• what services they offer and how much they cost
• how charges are levied – if there is a fee per transaction or a one-off charge
• whether there are any additional charges – some banks charge for sending out letters or if you exceed your agreed overdraft limit
• whether there is a local branch – especially if you need to make frequent cash transactions
• if there are special offers for new businesses or for transferring from another bank
• whether they offer telephone or internet banking – especially if there is no branch local to you

You can compare the packages offered by different banks on the British Bankers’ Association (BBA) website- Opens in a new window.

You could also open a business account with your current bank if you are happy with their service – they may be supportive if you have a good financial track record and have built up a relationship with them.

Once you have chosen a bank, it is important to try and develop a good working relationship to get the most of its services. See our guide on how to choose and manage a business bank account.

Specialist banks

If your business operates in the charity or social enterprise sector – eg co-operatives, employee-owned businesses or social enterprises such as local healthcare or education initiatives – there are specialised social finance banks and other financial bodies that can provide finance.

Find out about sources of bank finance for social enterprises and charities on the startups website- Opens in a new window.

Specialist loans that comply with Islamic Sharia law are available for business owners regardless of religion. In Sharia law, the giving or receiving of interest is prohibited and money must be invested ethically. The Islamic Bank of Britain and many high street banks provide Sharia-compliant lending.

Find out about Islamic finance on the Islamic Bank of Britain website- Opens in a new window.

Your choice of bank could be based on their ethical or religious standing – whether its investment policies take into account human rights, corporate and environmental responsibility and ‘fair trade’ issues. Find out about ethical investing and banking on the Ethical Investment Research Services website- Opens in a new window.

Private banks

Private banks offer bespoke financial services and avoid packaged deals normally associated with high street banks. They generally have a diverse range of products and lending services that meet the individual demands of private individual and business clients – eg lending and deposits, investment and wealth management and savings.

Private banks aim to have a more relationship-based approach to banking, structuring financial solutions and packages to suit each client’s unique financial circumstances.

All payment service providers – including banks, building societies and payment institutions – must be registered or authorised by the Financial Services Authority (FSA) under the Payment Services Regulations 2009 (PSR). They are also required to comply with the Banking Conduct of Business Sourcebook (BCOBS) for financial transactions where both the payer and payee are based in the European Economic Area.

The BCOBS sets standards for the type and format of information that must be provided, what charges can be made and maximum transaction times that must be met under the PSR. Find information on the BCOBS on the FSA website- Opens in a new window.

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Obtaining a loan and offering security

When securing a loan, there are certain requirements you may need to fulfil. Most lenders require you to:

• share the financial risk by providing capital up to the same amount as you want to borrow – demonstrating your commitment and providing a contingency for repayment if things go wrong
• provide security for borrowing requests – eg personal or business assets, such as your home or business premises
• provide personal guarantees if you run a limited company, and the business cannot offer adequate security
• keep them informed of your progress, particularly changes or problems
• have a comprehensive business plan and cashflow forecast for larger borrowing requests
• have a good credit record – including a good payment record with other creditors

For information on banks’ credit rating and scoring, see the page on credit rating and scoring in our guide on obtaining bank financing.

Agreeing the terms of your loan

Aside from discussing basic issues, such as the due date of the loan and the interest rate, you also need to:

• establish what the lender’s loan fees are
• agree the covenants
• check if you can make overpayments
• see if there is an early repayment charge
• find out if you can take ‘repayment holidays’
• check to see that late payment charges are practicable

It is often a good idea to seek professional advice on the terms of the loan and security requirements. They can help you choose the type of loan and lender best suited for your business.

Find a financial broker on the National Association of Commercial Financial Brokers (NACFB) website- Opens in a new window.

For more information about raising finance for your business, see our videos about understanding business finance on the Business Link YouTube channel- Opens in a new window.

Standards of conduct for lenders

The Lending Standards Board has replaced the Banking Code Standards Board. The British Bankers’ Association (BBA), Building Societies Association and UK Cards Association lending code aims to ensure that business standards are maintained when providing overdrafts, unsecured loans and credit cards to personal and small business customers. Under the code, you can access information on how credit assessment should be carried out and how to manage cases of financial difficulty.

The code also makes new requirements on risk-based re-pricing, a period of grace for credit card customers in financial difficulties, and good practice for dealing with customers with a mental health condition who are in financial difficulties.

The lending code is a voluntary code of practice for financial institutions to follow when dealing with personal and business customers with an annual turnover of under £1 million. There are specific principles that commit banks to working in partnership with small businesses to ensure the best possible outcome for the business, its employees and community.

Businesses with an annual turnover of more than £1 million come under the general principles of the Financial Services Authority.

Read the BBA’s principles for lending to small and medium-sized enterprises on the BBA website.

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Providing a guarantee for your loan

If your bank agrees to lend you money, it may require a guarantee. A guarantee is a promise by a person or an entity to assume a debt obligation in the event of non-payment by the borrower. Your loan agreement should make it clear exactly what security the bank needs.

Guarantees can be provided by:

• you, if you run a limited company
• other people involved in the business

Banks may also ask another person or business to act as a guarantor. If you cannot meet your repayments, the guarantor may have to pay part or all of the loan or interest.

If you operate a limited company, banks and major creditors will usually require personal guarantees from the company directors or major shareholders.

Limited liability protects shareholders from being sued by the business’ creditors for their personal assets. Where a personal guarantee for a bank loan is issued, the guarantor can be held personally liable for the debt.

If possible, ensure that personal guarantees only apply to specific debts or loans as a widely drawn guarantee would render you liable for all of the losses of the business up to the amount of the guarantee. Under the lending code, guarantees given in support of bank account borrowing must not be for an unlimited amount.

Find information on the Lending Code on the Lending Standards Boards website- Opens in a new window.

See our guide on obtaining bank financing.

The Enterprise Finance Guarantee

If you need funding for your business, but cannot secure a loan, you may be eligible for the Enterprise Finance Guarantee (EFG). Its aim is to encourage and support additional commercial lending to viable businesses with an annual turnover of up to £25 million that lack security, and are seeking loan facilities of between £1,000 and £1 million. You will still need to prove to the lender that the business proposition is viable and that you can repay the loan in full. The lender is not obliged to provide finance, even if you believe your business is eligible.

Find out about the Enterprise Finance Guarantee on the Department for Business, Innovation & Skills (BIS) website- Opens in a new window.

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European Investment Bank funding for small and medium-sized businesses

A number of UK high street banks have secured financing from the European Investment Bank (EIB) to provide lower-cost long-term loans to small and medium-sized enterprises (SMEs). If you run a business with 250 employees or fewer you are eligible to apply. However, you cannot apply if you operate in sectors such as the arms trade, gambling or tobacco.

The key benefit of an EIB-funded loan is that it may provide cheaper credit. This is passed on to your business either directly through a reduced loan cost or via cash back. The only restriction is that the loan must be for a minimum of two years and the loans cannot be for short-term working capital needs.

How to access an EIB-financed loan

EIB finance is not packaged as an ‘EIB loan’ by the banks. To access an EIB-financed loan you should apply directly to one of the participating banks. If you ask about EIB finance in a branch of one of the participating banks, you will probably be referred to a relationship manager since the size of the loan will usually be higher than normally dealt with at branch level.

Applicants for this type of loan will be subject to each bank’s own lending criteria, credit assessments, and terms and conditions, which may vary.

There are several banks offering EIB-financed loans in the UK.

Download a list of financial institutions offering EIB loans in the UK from the EIB website (PDF, 25K)- Opens in a new window.

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Here’s how my business benefited from taking out a loan

Oscar and Fitch is the brainchild of Scottish lab owner and designer Drew McDonald. McDonald formed a lens prescription company, Oneoptical, in the early 1980s. The business has flourished and there is an Oscar and Fitch store in Edinburgh.

Transcript

Drew McDonald: “My name’s Drew McDonald and I own and operate an eye glasses company called Oscar and Fitch, based in Edinburgh.”

“We’re trying to offer customers a different approach, so rather than traditional opticians, we don’t test eyes but we give our customers a styling session. Our mission’s really to try and make people make the best of what they’ve got, look better and get to keep their house. It’s not a remortgaging job.”

“Behind Oscar and Fitch is my manufacturing company One Optical, which I started in 1982. So in the east end of Glasgow we have a factory and we manufacture lenses. There would be no manufacturing business were it not for the Clydebank Enterprise Fund, whom I approached in 1982 as a 22-year-old.”

“Well, in 1982 credit cards were not something that was on most people’s radar. I didn’t have any family money, my own resources were very limited and with what little money I had I was able to approach a fund, which was based in Clydebank: it was a fund to regenerate small, little businesses. And my company, at the time it was named Clyde Optical, started at that time. The funding was actually a joint fund, it was the Bank of Scotland and European Coal and Steel Communities Fund. So we got a loan back then of fifteen thousand pounds (£15,000).”

“We were able to service the loan out of cashflow and profitability of the company and repaid in line with the repayment schedule. The grant thing, for the very modest investment at the time, wouldn’t have warranted meeting all of the requirements.”

“I invested the money in setting up a small factory unit, so most of the money went on machinery. The benefit of the loan was immediate because out of nothing we’d started a little, tiny business. We got a concession on the unit, I think it was rent free for three years, so all of these things were a huge help to get the thing out of the starting blocks.”

“Don’t be frightened of taking out a loan. Don’t take out a loan to buy a new car or go on vacation. For a business, if it’s a sound proposition and you believe it to be so, it’s fine. It was easy for me, I was very young, but people who at any point who do summon up the courage for that leap in faith, when I talk to them now many of them say, ‘I wish I’d done it years ago.’”

Disclaimer: The material in this audio/video may include the views or recommendations of third parties, which do not necessarily reflect the views of Kraken, or indicate its commitment to a particular course of action. We assume no responsibility or liability arising in respect of any such third party material.

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Here’s how securing the right loan helped my business develop

James Sirrell founded electrical contracting business Spectrum ESM in 2006. The company, based near Lutterworth, Leicestershire, used an overdraft facility and a loan to help fund its unexpectedly fast expansion.

WHAT I DID

Arranged an overdraft to help my cashflow

“I went from employing two people to using 12 within a few months. That saw my wage bills going from around £3,000 to £16,000 a month. Cashflow became a massive problem.

“I have a £12,000 overdraft limit now and once a month I go up to it. It costs me at the end of the month whatever the interest is, but it’s not a massive amount.

“We couldn’t operate without it. Wage bills, the VAT return, buying new materials… it all won’t wait, and 30 to 60 days is not an uncommon time for us to have to wait for payment from jobs. The funds enabled me to continue to take on customers and develop.”

Kept in close contact with my bank manager

“I developed an excellent relationship with my bank and now speak to the bank manager every week to tell him what’s happening.

“I used to go over the overdraft limit every month as I took on big jobs and struggled to cope but things have been getting better and better. The first month I stayed within my limit the bank manager actually rang me up to congratulate me.”

Use my loan as backup

“Early into my second year, a company we did a lot of work for went into insolvency. We had about £23,000 tied up with it. I couldn’t increase my overdraft or get a business loan as Spectrum ESM was still quite new, so I took a £13,000 personal loan to keep the company going. I arranged it on the phone with a high street building society and didn’t need any collateral.

“In this trade if you don’t have the money to buy the materials – cables, switches, sockets, trunking, lights – you can’t do the job. We have subcontractors who work with us and they expect to be paid every week, too.”

WHAT I’D DO DIFFERENTLY

Change banks earlier

“My first months were hard work. Telling your lads you can’t pay them is very difficult. I should have moved banks straight away when the first one wouldn’t give me an overdraft. An overdraft for me is a business essential.”

Protect against non-paying customers

“If I’d taken out insurance with my bank against customers defaulting on their payments, I would have been paid when they went insolvent. If they don’t pay up you can claim it through your cover. The bank credit check your customers as part of the cover, to assess the risk – so the bank has the risk not you.”

Plan to fund growth

“Grow slow, don’t grow too fast as we did in our first couple of years. That’s why we had a cashflow problem. Walk before you run. Get a couple of years under your belt and some money in the bank before you take on big jobs and start expanding.”

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