Bank loans are one of the most common forms of finance for small and medium-sized enterprises (SMEs).
They are generally a quick and straightforward way to secure the funding needed, and are usually provided over a fixed period of time.
Bank loans can be capital/principal repayment or interest-only and can be structured to meet the business’s needs.
For businesses seeking to purchase business premises, commercial mortgages are widely available and will, in general, offer flexible terms.
Bank loans can be short term or long term, depending on the purpose of the loan.
Bank loans are frequently used to finance start-up capital and also for larger, long-term purchases.
There are five main direct costs that need to be considered:
- arrangement fees
- covenant compliance costs
- professional advice.
Bank loans are normally provided at a cost, which is generally interest on the owed amount. Other fees and charges may be applicable, depending on the type of loan and on the lender.
Arrangement fees are commitment or administration charges payable to the lender to reserve the funds and to cover opening costs. Fees will vary depending on the complexity of the business, its size and risk.
Interest is charged and will vary depending on risk of default. The most common types of interest rate will be fixed or variable (a margin over base rate or London Interbank Offered Rate [LIBOR]).
Insurance, especially key person insurance, may be a condition of the loan application. The amounts and cost of this insurance varies, obviously being dependent on the health history of the insured person.
Better rates can normally be obtained when the bank loan is secured, as the risk to the lender will generally be lower. The security provided by the borrower can be business assets, guarantees or security or third-party guarantees or security.
This also applies when loan covenant or other information is required by the lender as a condition of granting the loan and as a condition of continued availability of the loan. Information such as current management accounts and/or cashflow projections can be requested on a regular basis, which will be agreed prior to sanctioning. Therefore, the costs associated with creating and supplying such information should be taken into consideration before entering into a contract with a lender.
Legal fees will vary depending on if other services are provided, the complexity of the business, its size and risk to the lender. Fees are likely to apply when a personal asset, such as a jointly owned property, is provided as security.
Fees to prepare management accounts will vary depending on whether other services are provided; bookkeeping, for example, and also on the complexity of the business, its size and the frequency of issue. A business would commonly be charged between £250 and £1,000 per preparation.
The timeframe for arranging a bank loan will vary, depending on the stage of readiness of the business and the type of loan applied for. Unsecured loans can take between one to four weeks, whereas secured loans can take between two to three months.
Timings will also depend on whether new security, new valuations or legal advice are required.
- suitable for medium- and long-term borrowing needs
- the loan amount, length of term, repayment schedules and type of interest rate can be tailored to suit the business, including both cashflow and income generation
- repayment holidays may be available
- funding is not dependent on giving up a share of the business
- this type of borrowing usually has a lower rate of interest than more flexible (ie short-term) options
- interest and arrangement fees are normally tax deductible
- the matching of fixed assets and long-term loans will improve the business’s net asset position on the balance sheet
- making timely loan repayments may improve the business’s credit score.
- not as flexible as short-term solutions. For example, if the loan is repaid early, additional fees may be applicable
- the lender may not grant the entire amount requested, as the business’s financial situation will be taken into consideration
- as with other types of debt, if the loan is secured and the business fails to repay, the lender may take action to seize the security provided for the loan
- not ideal for cases where it is difficult to assess the amount of funding needed
- time will need to be spent preparing management accounts and monitoring compliance with covenants
- a loan is not flexible and may not provide the best use of capital for businesses with fluctuating finance requirements
- defaults on loan repayments can lead to a fall in credit score, increased interest rates for existing and future loans, collateral being seized and legal proceedings against the company. Company directors may also be personally affected, depending on how the loan was structured.