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Bank loans advantages and disadvantages for small businesses

Written By:
Myles Robinson - Expert Finance Advisor

Posted: Jan 4, 2023

Fact Checked By:
David Nicholson - Finance Editor

Small business bank loans pros & cons

Bank loans are a great option for businesses looking for additional financing.

What are the benefits and drawbacks of this funding source for business loans?

Small businesses and start-ups looking to expand have one thing in common: they need additional funding to help cash flow or to grow the business.

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While it would be great if they could fund their plans with their own funds, most small businesses don’t have the capital to invest in their growth.

They would have to look to outside sources to fund their growth plans.

This raises the question: Which type of funding would be most suitable for your company and your needs? There are many options.

Although business loans are the most common source of financing, a wide range of options are available to businesses.

You can get short-term loans, long-term loans from traditional high-street banks, unsecured loans, and secured loans. Terms range from one to 25 years.

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Reasons for a small business to apply for a bank loan

There are many reasons to apply for a business loan. You can apply for financing for your start-up costs, equipment purchases, expansion of the workforce, stock purchases, and other operations.

Lenders, including banks, have created specialised products to meet this range of needs. These include asset financing, invoice financing, and working capital loans. This is to help businesses find the right type of finance to suit their circumstances.

How do you determine if a loan for a business is right for your company? How do you choose the right type of loan for your business?

Learning more about bank loans and other lending sources is a good idea before comparing small business loans.

This article will explain the benefits and drawbacks of small business bank loans. It will help you decide whether they are the right option for your business or not.

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What are the advantages of bank loans?

1. Help you grow your business

Bank loans can be a convenient way of getting additional finance without having to wait for your business to generate enough profit to allow you to expand.

You can take out a loan to help you put your plans into motion sooner and make the most of any opportunities that arise, which will allow for faster and more rapid growth.

Although it may take several weeks or even months to get approved for a loan from the bank, this is still an effective way to raise funds to expand your business.

2. Your company remains in your complete control

As with all small business loans, the main benefit of a bank loan is that you can get a cash injection without having to give up control of your company.

You will need to sell your company’s stock to raise funds immediately. Equity finance is another funding option.

A small business loan is temporary, and you won’t be obligated to the lender after you have paid off the loan.

3. Reputation

A bank’s trusted reputation and familiarity are two key factors that set it apart from other options for lending.

Due to the bank’s long-standing reputation and security, small businesses might prefer to apply for bank loans.

Although the older, more established banks may seem more trustworthy than online-only lenders at first glance, this view is becoming less common as online lenders are more accepted and more widely used.

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4. Bank interference is not allowed

A small business loan from a bank is a great option because banks won’t restrict your ability to use the loan.

To help the bank assess your risk in lending money to your business, you must submit a business plan when you apply for a loan.

Once you receive the funds, you can change your plans at any time, provided that the bank does not intervene.

5. Favourable interest rates

A small business loan from a bank can have interest rates that are lower than online lenders.

A bank loan is a better option than an overdraft, credit card, or personal loan, especially if you’re looking for long-term funding.

Banks are a cost-effective option for businesses with good credit scores and good financial histories.

Banks will be less likely to approve your loan application and offer attractive interest rates for established and well-respected businesses. Secured loans can also be beneficial for lower interest rates.

A bank loan for a small business has another benefit: the interest you pay on the loan repayments can be tax-deductible.

6. Banks may offer additional services

If you have a relationship with your bank and have an account, for example, they might be able to offer you advice on lending based on their knowledge of your business.

A personal advisor may be available to answer your questions about the lending process. Online lenders may not be able to offer this personal service, which can be a benefit of a small-business loan from a bank.

This doesn’t necessarily mean your bank or any other bank is your best option.

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What are the disadvantages of bank loans?

1. Eligibility criteria must be strict

Bank loans can be hard to get for small businesses because banks are often cautious about lending to them, making small business loans tough to get.

Because banks have strict lending criteria, it can be difficult for newer businesses and start-ups to get approved for loans. If they do accept, they will likely increase the interest rates to offset the increased risk.

Therefore, more established businesses with a strong credit history are likely to reap the benefits of traditional bank loans and expand their business much quicker.

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2. Long application process

It can be time-consuming and tedious to prepare for a loan application. To prove your business is a viable lender prospect, you will need to complete an application form for each lender.

It can take traditional banks a while to process the information and make a decision, particularly if you are applying for large amounts of money.

Businesses looking for a quick cash injection may not be able to obtain this loan from a bank.

3. The loan amount may not be fully repaid.

There is a possibility that your bank won’t approve your loan for the entire amount you requested.

The bank might decide that your company doesn’t require the money required to complete your project or may not lend you the entire amount.

Businesses may wish to create an alternative plan if they are only granted a portion of the requested funds.

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4. This is not the right choice for continuing expenses

Another disadvantage of a bank loan is that you cannot use it for ongoing expenses or projects that will grow your business.

Banks want to lend money to businesses that can repay it. They will therefore look for businesses willing to invest, grow and return the money.

Other financing options, such as business credit cards, overdrafts or working capital loans, may be better suited for small businesses that need funding to address a temporary cash-flow problem or to inject cash quickly.

Some other cash flow loans, such as popular invoice finance, may be an option or invoice discounting, which are for businesses that are experiencing cash flow or need invoices paid sooner than they’re due.

5. Secured loans come with risk

While a secured loan from the bank may be a good option due to its lower interest rates and potential benefits, businesses must remember that it puts their assets at risk if they default on repayments.

While businesses may not intend to make all payments, it is something that you need to keep in mind when applying.

Although there is a risk involved, securing a loan against business assets will ensure that your personal assets (such as your home) are not affected by default.

Read our guide on business loans vs personal loans, which can help give more information on this.

However, there is an exception as banks may be able to secure loans against your personal assets in certain cases if the company does not have collateral.

This type of loan, also known as a personal guarantee or director, would require collateral such as your house. If you default on your payments, your home could be at risk.

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Do you have other small business funding options?

A small business may consider other funding options if they aren’t certain if bank loans are right for them.

Small businesses have other options than banks for lenders. Online lenders are increasingly popular and viable options for small businesses seeking funding.

Online lenders are more likely to lend to small businesses with less credit history or established credit than banks.

However, this could result in higher interest rates. If you have any impaired credit, then it is advisable the fix your business credit rating before applying.

Online lenders and traditional banks are not the only options for business loans.

Small businesses and start-ups have other options unless your business has bad credit, which will make it hard for you to get loans.

The government-backed start-up loan offers loans to companies that have been in business for less than 24 months.

To determine if specific loans are right for your business, you might also consider asset financing or invoice financing.

Small business owners might also look into other financing options, including crowdfunding, equity finance, peer-to-peer funding, and business grants.

These grants are extremely competitive because they are not repayable.

However, many regional and national small business government grants are available for many different schemes and projects.

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