Choosing the right bank for your business
In this guide:
- Bank finance
- Types of bank finance for businesses
- Is your business ready for bank financing?
- Advantages and disadvantages of bank loans
- Advantages and disadvantages of overdrafts
- What you need when applying for a bank loan
- Where to look for a bank loan
- Choosing the right bank for your business
- Providing a guarantee for your loan
- Apply for bank finance: step-by-step
Types of bank finance for businesses
Sources of short- and long-term bank finance for businesses, including overdrafts, bridging finance and mortgages.
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.
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 factoring and invoice discounting.
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.
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 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 commercial mortgages and lenders.
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.
Banks may also provide a range of specialist services to fund expansions, mergers or acquisitions. For more information, see 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 non-bank finance.
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Is your business ready for bank financing?
Even before seeking finance, you need to be clear in your own mind about why you need it, and how much.
When you seek finance for your business, you will give yourself the best possible chance of success if you are clear about your business' requirements. Consider the following:
1. Why do you need business funding?
It may be to finance business expansion, to develop or exploit new products, for new premises or a number of other reasons. It should be for something specific, and be carefully costed. Banks will want to know the business case before they agree to supply funding, so you should think about the reasoning, the potential outcomes of the investment and how you will repay the finance.
2. How much funding do you need and when will you need it?
Although it does not make business sense to borrow more than you need, you should be careful not to underestimate - aim for the optimum amount. You should also consider whether you need all of the money at once, or whether staged amounts would work, as this may reduce the cost of borrowing with lower interest costs and initial repayments.
3. How are you going to repay the borrowing?
You will need to repay the loan in the future, with interest. Ask yourself when you are likely to start seeing a return on your investment, and how much the monthly repayments will affect your cashflow.
4. What is the right source of finance for you?
There are several different types of investment finance, and you will stand a much greater chance of securing financing if you can clearly explain why the source you are approaching is most appropriate for you, and any potential drawbacks.
For more information, see types of bank finance for businesses.
5. Is there anything that would impact your chance to borrow?
There are some things which will weigh against an application for loans or other funding:
- unauthorised overdrafts
- missed loan repayments
- County Court judgements against the business or its directors
- adverse credit rating data, against the business or its directors
There are also some factors which would automatically disqualify a potential borrower. These include:
- a history of illegal activity on the part of the business or individual
- if the business is in administration, or the individual has bankruptcy proceedings in process against them
- where the potential borrower is under the age of 18
- when the business could pose a risk to the reputation of the bank
Bank finance may not be the best option for your business and there are a number of alternatives available to you - see business financing options - an overview.
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Advantages and disadvantages of bank loans
What loans are, their advantages and disadvantages, and how to know when they are suitable for your business' needs.
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.
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 business financing options - an overview.
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Advantages and disadvantages of overdrafts
The flexibility, advantages, drawbacks and costs of using an overdraft facility.
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.
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What you need when applying for a bank loan
Banks have a number of core criteria which they will take into account in assessing your finance application.
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 cashflow management.
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 tailor your business plan to secure funding.
Further requirements
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
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.
Standards of conduct for lenders
The Lending Standards Board (LSB) provides standards for business customers and sets the benchmark for good lending practice in the UK, outlining the way registered firms are expected to deal with their customers.
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Where to look for a bank loan
Potential lenders for a business bank loan and how to secure a loan and get the best deal.
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 business financing options - an overview.
Getting the best loan deal
You should take care to choose the right loan option that best suits your business needs.
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.
- Use a finance broker - this can save you time and increase your chances by presenting your proposal efficiently to appropriate lenders.
- 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.
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Choosing the right bank for your business
How to find the right bank for your business and information on specialist and private banks.
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
Better Business Finance provides further information on business bank accounts.
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 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.
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.
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Providing a guarantee for your loan
How loan guarantees can help you secure funding, and details of personal and limited liability.
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 Standards Board Standards of Lending Practice.
The Enterprise Finance Guarantee
If you need funding for your business, but cannot secure a loan, you may be eligible the British Business Bank's Enterprise Finance Guarantee (EFG).
EFG facilitates lending to smaller businesses that are viable but unable to obtain finance from their lender. Support includes:
- term loans
- revolving facilities, such as overdrafts
- invoice finance facilities
- asset finance facilities
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Apply for bank finance: step-by-step
Before applying for bank finance, take a step-by-step approach so that you have the best chance of success.
When you apply for a bank loan or overdraft, you should take a step-by-step approach to make sure that you give your application the best chance of success.
Banks often have requirements checklists on their websites, or you can use this checklist as the basis for your application:
- Background - explain, in writing, the key details about your business, including ownership, management team (including its experience), history and growth development. You should also identify the most important influences on your business, including your main customers, key suppliers and major competition.
- Purpose - explain in detail why you want the loan or overdraft, including an indication of your aims and objectives. If you have had loans previously, explain what they enabled you to achieve.
- Risks - demonstrate that you know and understand the risks that might impact on your business, and show how you have taken steps to reduce their effect, as far as possible.
- Finance - explain who looks after your business' finance, outlining their experience and qualifications. Show that you have solid financial systems in place.
- Accounts - you'll need to provide financial data. Most banks will want to see annual accounts for the previous three years, as well as management accounts, budgets and forecasts. If you are a new business, or if you are moving to a new bank, you will need additional information such as previous bank statements and figures showing your personal financial situation.
- Amount - outline what funding you are seeking, including what it will be used for. If you are looking for an overdraft, make sure it takes into account your needs for the foreseeable future.
- Funding structure - the bank or your accountant will be able to help you decide the best type of finance. It is important to have the right kind of funding structure to cover both working capital and capital investments.
- Repayment - you need to be clear about how you are going to repay the borrowing. Be realistic about your business expectations and cashflow, and avoid being over-optimistic.
Security
Banks will often require your loan or overdraft to be secured when borrowing larger amounts. This can include charges over property or the company's debtors, personal or third party guarantees, or government support.
Professional advice
Your accountants, solicitors or trade bodies can provide help in structuring your case, and the bank itself will probably be able to help with loan documentation. For information on finding professional advisers, see choose an accountant for your business and choose a solicitor for your business.
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