The advantages and disadvantages of bank loans for small businesses

Bank loans for small businesses can be tricky to navigate unless you know what to expect and whether the advantages outweigh the disadvantages.

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Bank loans for small businesses provide working capital for projects that may be considered too pricey to fund internally. This could be for expansion, stock injection, or even to finance a new asset. While other means of funding these projects exist, a popular option for businesses is to seek a loan. Before approaching a bank, business owners need to be fully aware of the advantages and disadvantages of bank loans for small businesses. 

Advantages

You keep ownership of your business

If you were to approach an investor for funding, they would want a return on their investment. In many cases, simple repayment of the loan would not be enough; the investor would also require a share of your business. If you did this enough times, you might no longer be a majority shareholder in the business. Banks, on the other hand, don’t require a share in the business for the loan.

The finance period is temporary

A bank loan has the advantage that it has a fixed term: you are only tied to the bank for the finance period. With other types of funding, to loosen ties with the other parties might require you to buy them out once the project is completed.

The finance is asset-specific

Seed investment from an investor might be to reach certain expansion or growth goals within the business. This can leave many grey areas, as the extent of the investor’s participation and reward becomes linked to performance and not the asset it’s funding.

Monthly payments are predictable

For small businesses, having a predictable cash flow is important in order to budget accordingly. With a business loan from a bank, the repayments are predictable and rarely fluctuate, especially if the loan has a fixed interest rate.

The business builds a credit reference

Perhaps one of the most important reasons to seek out finance from a bank is the business credit reference. Those businesses that build up a healthy score with a bank may have a better chance of securing additional finance if needed. This also acts as a good reference should a business wish to open a supplier account.

Disadvantages

Not easy to qualify for

Before qualifying for a bank loan for small business, there are quite a few hoops to jump through. And these hoops are filled with document requirements. These documents could include financial statements, letters of intent, and more. Some applications may even require feasibility studies, business plans and due diligence reports. Depending on the risk of the application, the bank may also require collateral – which small businesses may not have. 

High interest rates

Business loans can be expensive, as banks may adjust the interest rate according to the risk of the borrower. Even if the interest rate is considered low according to industry standards, this all adds up over the term of the loan.

Inflexible payment schedule

Businesses will need to make the necessary shifts in their cash flow to accommodate their loan repayments. This can be tough for seasonal businesses to manage; for example, if the loan repayment is £500 per month, it will be £500 in good months and in bad ones. While businesses may apply for payment holidays, these are at the discretion of the bank and not always granted. Having a payment holiday may also reflect negatively on the business’s ability to service a loan.

Personal collateral might have to be used

When a loan calls for collateral and the business doesn’t have any assets, the owners of the business might have to offer assets of their own. This could be in the form of fixed deposit accounts, equity in their property, or insurance policies that have a cash value. If the business defaults on the loan, the bank can go after these personal assets.

Long wait for approval and disbursement

Business loans can take some time to process, even when all the documentation is provided. There is the possibility of the application going back and forth between your banker and the credit team if the approval requires a higher mandate. Once the loan is approved, other delays can creep in such as waiting for the collateral to take effect or for other terms to be met before the actual disbursement. 

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