If you can’t get a business loan from your bank, you might look to the alternative finance market for a solution. But simply asking about ‘business loans’ doesn’t narrow down the process as much as you might think — and there are in fact many different types of business loans available to suit a wide variety of different businesses.
Here are five types of business loan that represent just some of the products available:
Business loan 1: Secured
Secured business loans are probably the most straightforward type of business loan — and they’ve been offered by the mainstream banks for years. They get their name because they’re based on security: valuable assets in your business that can be sold if you can’t keep up with repayments.
Alongside the traditional bank products, there are more and more alternative lenders nowadays using more creative forms of security.
Secured business loans: pros and cons
- Based on assets, which determine the amount you can borrow
- If you have ‘unencumbered’ assets you can usually borrow up to their total value
- Assets need to be valued — which can lead to setup costs and delays
On the other side of the coin are unsecured business loans, which (predictably) get their name because they don’t require security. Unsecured business loans are a good option for fast-growing firms in need of working capital to keep expanding — particularly if they don’t have enough assets to get a large enough secured loan to achieve these goals.
However, to get an unsecured business loan, your business will usually have to demonstrate a robust track record and present detailed accounts, and you might have to offer a personal guarantee.
Unsecured business loans: pros and cons
- No need to have any business assets
- Good fit for high-growth, fast-paced firms
- Solid trading history or high potential need to be demonstrated
- Personal guarantee may be required
Business loan number three is based on revenue — both in terms of the amount you can borrow, and the way you pay it back too. It’s technically another type of unsecured business loan, albeit with more specific restrictions.
With revenue loans (sometimes known as turnover loans), the amount you can borrow is expressed as a percentage of recent monthly revenues. While you might be able to get a loan worth, say, 150% of monthly revenue, it’s unlikely to be a significantly larger amount than that — which could be restrictive depending on your plans.
Revenue-based business loans: pros and cons
- Like unsecured business loans, but directly based on revenues
- Potentially simpler process
- Limit to the amount you can borrow
Although business loans based on receivables seem similar to revenue based loans, the important difference is that instead of being based on overall turnover they’re based directly on money owed to your business — in the form of specific customers or invoices.
Invoice finance is effectively a business loan based on one invoice, a group of invoices, or the whole sales ledger — you’re advanced a percentage of the cash, then once those outstanding payments are settled you get the remainder minus the lender’s fee.
That’s the general idea behind all types of business receivables loans, but there is a lot of nuance in this area, with multiple variations of invoice finance on the market.
Receivables business loans: pros and cons
- Better suited to cashflow management than growth
- Creditworthiness of customers is important consideration
- Simple way to access revolving credit
The peer-to-peer sector is perhaps still the best-known area of alternative finance. It works by connecting investors with businesses looking to borrow, combining multiple ‘lenders’ into one business loan.
In theory, peer-to-peer offers a good return for investors and a reasonable interest rate for borrowing businesses; it’s this ‘everyone wins’ image that has captured the public imagination. In reality though, ‘the crowd’ is often backed by a single investment fund, meaning the distinction between P2P and standard business loans from lenders is increasingly moot.
Peer-to-peer platforms will often have stringent eligibility criteria to protect their investors. On the other hand, for eligible firms, it’s a simple way of accessing patient capital for growth.
Peer-to-peer business loans: pros and cons
- Unknown businesses can raise significant capital
- Sometimes easier to get than other forms of unsecured business loans
- Unglamorous businesses can struggle to appeal to investors!
These are just five types of business loan. Whether you’re looking for a long-term growth fund or just something to tide you over until the next contract is paid, there are business loans for many different sectors and purposes. And clearly, thanks to alternative finance, ‘business loans’ isn’t as descriptive a phrase as it once was.
By Conrad Ford, chief executive of Funding Options