With the economic climate as it currently is, businesses are having to overcome more challenges and navigate difficult landscapes to survive. It’s during times like these that having cash reserves can really be the difference between being able to weather the storm and going down with it. Unfortunately this means that more and more high rate, unsecured loans are being offered as a solution to this, in place of more competitive and appropriate finance solutions. So when should you look to take out a loan and when should you avoid it like the plague?
A business loan is a type of finance used to raise funds that doesn’t relate to a particular asset. The generally unsecured nature of a loan, means that the rates are significantly higher than their secured finance counterparts. Loans will also always require directors’ guarantees, unlike asset finance where the security is, in most cases, provided by the asset itself.
The use case of a loan is incredibly important, as unless used for the right reasons, they can cause more trouble than they ease. Where at all possible, loans should only be used where a lower cost finance option isn’t available and it is for a revenue generating activity such as implementation of a marketing plan, taking on more sales team members or launch of a new product. Loans shouldn’t be used as a sticking plaster for working capital holes unless the cause of this has been clearly identified with a plan to rectify the issue. Otherwise a loan will only compound the problem and delay the inevitable increasing debt when that point is reached. An example of this is utilising a loan to pay wages, suppliers etc. when the need is caused by slow payments from clients. Rather than a loan, a review of your payment terms, credit control or potential finance facility would be a more appropriate action, as this actually addresses the root cause.
If, with the help of your accountant or a reputable broker, you have determined that a loan is the only route available to you, consider the following:
- What level of funds do you actually need and can you comfortably service?
Many loan funders/brokers will maximise the approval and offer you more than your initial request but every pound should have a purpose and without a purpose it can cause affordability issues. - Has security been requested?
As there is no asset security such as equipment or property, loan funders may ask for charges over personal property or debentures. It is worth considering if this a level of security you are comfortable with.
- What is the rate and arrangement fee?
Consider whether the rate quoted justifies the spend and a return on investment will be made, either in the short or longer term. Arrangement fees aren’t always disclosed until further down the line and can be significant amounts of money, that should be considered when budgeting for the loan in the first place. - What are the settlement terms?
Many loan settlements will be calculated as all capital outstanding and interest accrued to point of settlement, but it is worth checking the individual requirements before going too far down the road.
Sadly a huge increase in the number of finance brokers in the last few years has led to loans offered to businesses without a true understanding of the impact this will have on the business. To establish whether or not a loan, and indeed which type of loan, is right for your business, the following questions should be asked:
- What is the loan purpose?
- What does the business’ cashflow cycle look like?
- Do you have any unencumbered assets?
- Does the business have an invoice finance facility?
- Are the repayments achievable and affordable?
Only with this information can a discussion be had as to the most appropriate finance solution.
Debt consolidation is also rife, with many brokers offering to settle off existing finance and putting onto a longer term reducing the monthly payments. Whilst from the outset this can seem harmless, potentially reducing monthly outlay, this is rarely the way this pans out. The majority of lenders don’t like debt consolidation and this is reflected in the rates and terms available. It is also essential to check the settlement terms of the existing agreement, as unless you are only settling the capital outstanding, you will be doubling up on interest.
Loans, when used in the right way for the right reason, can be valuable, however there is a lot of noise in the finance market at the moment that makes that difficult to distinguish. Your job is not to do the research and understand every available product on the market, but to know what questions you should be answering to ensure that you are working with someone who can. At Focus we write very few loans, as generally a loan is only an answer to a symptom – not a cause. We have over 30 years’ experience of the wider finance market and will always discuss all your options, so you can make the right decision for your business.