Small business loans: How to apply, pros, cons, and resources to guide you

Whether you are just starting out or are expanding your business, you might be needing some capital to put plans into action.

If you’re interested in applying for a loan, it can be confusing.

How do you know what kind of loan is right for you? 

It’s important to make the right decision as the type of loan you select will directly affect your tax obligations and cash flow.

We’ve got answers to your questions.

In this small business loans guide you’ll learn about:

• How to determine which small business loan suits you
• Types of small business loans
• Where to get a small business loan
• How to apply for a small business loan
• Other types of funding

Grab yourself a coffee and let’s walk through your options.

Deciding which small business loan is best for you

Be clear about the purpose of the loan

Your first consideration should be how much money you need and for how long?

If you are an established business that needs to cover sudden expenses, short-term financing is what you’re after. It could be either secured or unsecured and you’ll need to repay promptly. It’s risky to use short-term loans for major investments.

If you want to finance assets like vehicles and equipment, long-term financing is more appropriate. If you use long-term finance to pay a bill, cover revenue fluctuations or buy extra stock, you could be locked into an expensive loan long past the point you actually need it.

Calculate repayments

What can you afford to repay per month? Compare interest rates on various options and consider whether you have the adequate cash flow to fund the option.

Interest rates will vary depending on the type of finance, term of the loan, whether any security is provided, your personal credit profile, your business credit profile.

Consult the table below for a quick comparison of interest rates.

Money magazine have a tool to calculate total repayment and interest amounts on Australian business loans.

Fixed or variable interest rates

Where you have the ability to choose your type of interest rate, consider the stability of your turnover.

If you have low profit or your turnover swings, a fixed rate loan would be a safer repayment option. The more accurately you are able to forecast your income, the more likely you can bear a variable rate and be sure you could still meet repayments if the rate goes up.

Fees

Remember to look at all the terms of the loan to assess what it will truly cost you. It’s not just a matter of repayments, but additional fees such as set up and administration, which can really add up.

Collateral

Do you have any assets which you could offer as security for a loan? If not, you’re going to have to go for an unsecured option.

Guarantor

Do you have anyone who would be willing to guarantee your loan? If not, this could affect your eligibility for some loan options.

Tax implications

Apart from considering the cost of the loan product in terms of fees and charges, also look at how it will impact your tax assessment.

How long have you been in business?

Some loan products are only available to established businesses so new businesses more likely need to consider unsecured options that are easier to access, or consider other types of equity financing like venture capital, for start-ups, for example.

What industry are you in?

Some loan options are only available to certain types of businesses, so take a closer look at options which are particularly relevant for your field or purpose. Merchant cash advances are only an option for retailers and hospitality businesses. Or there’s a range of finance options if you’re specifically looking to pay for equipment, for example.

Before we dive into the different types of loan products, consult the table below for a quick overview of which types might be most relevant for your business.

Types of Finance

Loan options fit into two categories. Secured lending, where you use an asset to secure a loan, and unsecured lending, where you don’t provide an asset.

Unsecured lending

Where you don’t offer an asset, the lender reduces their risk by imposing lower borrowing limits, shorter repayment terms in addition to high interest rates.

This makes it a costly option, but also more flexible and immediate.

Here are the types of unsecured lending that could be relevant for small businesses.

Credit cards

Credit cards are a common option for short-term business finance. Due to their high fee structure, credit cards are easy to get your hands on and will save you money if you pay off your balance in full each month before the interest-free period expires.

The interest-free period starts at the beginning of a billing cycle and anything purchased during that cycle, whether on the first or last day, will be charged interest from the purchase date if you don’t repay the full balance by the due date.

If you don’t keep on top of payment, it could get dangerous. Business credit card interest rates can be really high – up to 20%. In addition, you’ll be lumped with

• Annual account fees
• Fees to use reward programs
• Fees for late payments
• Payment dishonour fees
• Fees for exceeding your credit limit

Most Australian SMEs have a business credit card even if they have no other form of debt as they are ideal for smaller purchases and paying bills. You can also earn frequent flyers and other rewards, although rarely do the value of reward schemes outweigh the cost to your business.

Unsecured business loan

An unsecured loan is a general purpose short-term loan supported by cash flow.

In this scenario, you would loan a fixed amount which your business will repay over generally 3-12 months, in regular instalments, often daily or weekly.

There’s usually a quick approval timeframe, so if you have a seasonal business or a business with a stable monthly cash flow and need to access funds quickly, this could be a relevant option.

Both banks and non-bank lenders have a number of options online – you’ll need to compare lenders to get the best rate.

If your business is relatively new or you are self-employed, the director of the business may be asked to provide a personal guarantee.

Depending on your risk profile, and capacity for repayments, you could borrow between $5000 and $500,000.

Obtain an Annual Percentage Rate (APR) to calculate what the loan will cost you over a year and compare with other lenders.

An unsecured loan is fast cash, but costly.

If it’s a stop gap measure, for example to close an important business deal, you could try to negotiate a discounted rate for early repayment if you could repay as soon as your business deal has gone through.

Unsecured loans have become a popular form of small business finance in Australia due to their accessibility, speed and flexibility.

Unsecured small business loan

This loan type which is growing in popularity in Australia, is specifically defined for businesses;

• With a minimum monthly revenue of $5000
• That have been trading for at least 6 months
• For an amount of up to $150,000

Like general unsecured loans, these loans can be accessed through banks or specialist small business lenders. You’ll often get a lower interest rate from a bank, but faster approval from a non-bank lender.

You often only need to supply your bank statements and can get same-day approval through a non-bank lender, but as with all unsecured lending options, they can be costly.

Unsecured overdraft/Line of Credit

The main difference between a loan and line of credit is that you won’t have to pay interest on funds you’re not using. You have an agreed credit limit and can only access funds up to that amount.

Like unsecured loans, a line of credit is general purpose and usually has a term of around 3-12 months.

Similar to credit cards, interest is often calculated daily and charged at the end of the month.

Merchant Cash Advance

This is a type of short-term loan for retailers or hospitality businesses that make a minimum average volume of sales via EFTPOS and credit card. You repay the loan in daily instalments as a percentage of your sales.

It’s quick to set up and has the advantage that repayments are tied directly to your cash flow so if your income fluctuates from day to day, this option is more flexible than making repayments on a fixed schedule.

However, interest rates can be as high as 200% APR (annual percentage rate) and lenders aren’t regulated like banks, so they have more freedom to impose their own restrictive conditions.

Secured lending

You could provide a personal asset or business asset to secure a loan. The lender may sell your asset if you’re unable to repay the loan. If you provide property, the bank holds the title to the property until the loan is repaid.

If you provide a personal asset, such as your home, as security, the two lending options available are a bank loan or overdraft.

Bank Loan

If your business is well established and you’re looking for an economical option for long-term financing, traditional business bank loans are the lowest risk option.

However, the eligibility criteria and application processes are onerous, which can make it a more difficult option for small businesses.

In addition, since bank loans are often more relevant for bigger businesses, the minimum amount you can borrow may also be beyond your needs as a small business.

For these reasons, small business owners are increasingly using non-bank financiers online.

Note that you could also secure a traditional bank business loan with property your business owns rather than a personal asset.

Overdraft

A business overdraft is linked to your business bank account with a pre-agreed limit which you can draw down. Once you withdraw with the overdraft, you’ll need to repay the withdrawn amount with any interest accrued, in scheduled payments, either weekly or monthly.

Overdraft facilities are generally used to finance day-to-day requirements like stock purchases, and are often only provided to businesses which have been successfully trading for three years and have a high turnover.

The interest rate is set by a risk margin the bank determines and you only pay interest on the amount of the draw down.

In Australia, business overdrafts are often used in the retail, hospitality, wholesale, automotive and manufacturing industries.

In addition to a single-use facility, which allows you to draw down and repay like a loan, a line of credit can also be structured as a revolving facility which allows you draw down and repay as often as you like within the term.

You’ll need to pay set-up fees and potentially ongoing charges, whether or not you use the line of credit, since a lender is essentially promising you access to this money whenever you want. As such, the lender can’t earn interest on these funds while keeping them available to you.

Alternatively, if you provide a business asset to secure the loan, there are a few options depending on the type of asset.

Stock – Trade finance

If you import or export products, this type of finance can provide a letter of credit, documentary collection or bank guarantees between the buyer and seller.

In some cases, a bank will make you an upfront payment as soon as they have proof goods have been shipped and then follow up payment with a buyer.

It’s a short-term finance solution which reduces the risks involved in import/export transactions.

Interest is charged on the amount provided for each trade transaction.

Outstanding invoices – invoice (debtor) finance

Invoice finance enables cash flow by getting your invoices paid immediately. It involves the sale of an asset, your outstanding customer invoices, to a third party, known as a ‘factoring company’.

The factoring company will give you up-front payment, usually between 70-95% of the invoice amount and once the customer has paid the invoice (to the factoring company), they will deduct a fee (around 3-5%) and transfer the remaining balance to you.

This option can provide working finance and meet short-term fluctuating needs, however you need to decide whether your customers would be comfortable with a third party dealing with them. Research factoring companies and how they collect and obtain payments, if you’re interested in this option.

Be aware that you may have to buy back invoices where the factoring company has been unable to collect payment for a customer and that if you end the arrangement, you’ll also have to buy back any unpaid invoices.

Equipment Finance

If you need to buy equipment, machines or vehicles, you can negotiate finance directly tied to the cost and expected lifespan of the asset you want to buy.

Since the loan is secured by the asset you purchase, it’s often quick and easy to obtain approval with non-bank financiers being faster than banks.

There are 4 types of Equipment Finance.

Chattel mortgage – you own the asset and offer it as a security.

Interest rates are quite low. You can claim back the GST on your next BAS although the accounting work involved might be more work than a business lease option. In addition, any residual balance is not tax deductible.

Commercial Hire Purchase – the lender purchases the asset and leases to your business over a set period of time for a fixed monthly repayment.

GST is not charged on the rental, but on the fees and interest. You can otherwise get a tax deduction when a vehicle is used for business purposes. You’ll pay more over time for the asset than if you bought it outright.

Finance Lease – you have some ownership benefits although the asset is leased to you.

You can claim a tax deduction for the lease payments and the equipment is not on your books as an asset, but since you won’t own the asset, you can’t use it for business tax benefits.

Operating lease – you can buy the asset from the lender at the end of the term.

It can be good for equipment with a short lifespan and rental payments can be claimed as a tax deduction. Be aware that when the lease expires, the terms are cancelled, so you may need to renegotiate the lease if you want to continue leasing.

Where can I get a small business loan?

Apart from banks, there are a lot of non-bank lenders on the market as well as specialist lenders and finance brokers. The best lender for you depends on the type of financing you’re after and you’ll need to shop around.

Banks

Speak to banks if you’re a well established business with assets to provide as security and are looking for long-term finance.

Non-banks

If you need money fast for a short-term solution or aren’t eligible for bank loans, look into non-bank lenders like Prospa, Capify, Shift or Sail, for example.

Small Business Loans Australia has an overview of some of the non-bank lenders.

Non bank lenders are gaining popularity in Australia and last year, they provided over $1 billion in finance to small businesses.

Peer-to-Peer (P2P)

Peer-to-peer is a form of personal loan where individuals loan from private lenders (their peers) over P2P lending platforms such as Society One, MoneyPlace, RateSetter and Harmoney among others.

P2P platforms take a cut of the loan transaction through a platform fee and sometimes, application fee.

P2P first appeared in Australia in 2010 and ASIC reported $300 million in loans were written in the last financial year.

The application process will be similar to that for a traditional lender as the platform assesses your ability to repay and will also check your credit report.

Alternatives

As discussed, there are alternative financiers involved in invoice finance or merchant cash advances.

Another alternative ‘financier’ is retailers. If you need to buy goods furniture, technology or equipment, many retailers offer store credit through a finance company. Generally, it’s high interest and suits businesses that can pay the loan off quickly within the interest-free period.

Or you might approach a family member or friend for a business loan. If so, be sure to get independent advice, set out the loan provisions and obligations clearly and carefully consider how such an arrangement might affect your relationship.

Applying for a small business loan

When applying for a loan in Australia, financiers consider ‘The 5 C’s’ –

Character, Collateral, Capacity, Capital, Conditions

1. Character

This relates to your reputation, integrity and willingness to repay.

The factors lenders consider are:

• Your loan repayment history
• Savings history
• Stability (e.g. years in profession)
• Credit bureau history e.g. Equifax, CheckYourCredit.com.au

The questions your loan application needs to answer are:

• Have you repaid your debts on time?
• Do you have a good history of saving?
• Do you have a stable income?
• Do you have a history of defaults or bankruptcy?

Information you should provide includes:

• Copies of all compliance related payments such as GST and tax returns
• Copies of bank statements for investments and savings
• Historical financial information
• Your Credit Bureau report

2. Collateral

Lenders will consider:

• The type of security you are providing
• The value of the security
• Security age, location and attributes

The loan application will ask:

• Is the security enough?
• Is it a security acceptable to the lender?

You should provide:

A detailed security register providing purchase date, current valuation, photos and any other relevant information.

3. Capacity

Capacity concerns your ability to repay the loan.

Factors lenders will consider include:

• Your income
• Any other debts you have
• Your living expenses
• If you have any dependants

The questions your loan application will need to answer are:

• How much do you earn and is it sufficient to meet your repayments?
• How stable are your earnings – will you continue to be able to ‘service’ your debts?
• What are your plans if your situation changes?

Information you should provide includes:

• Budgeted Profit and Loss statement
• Cash flow forecast
• Risk management strategies
• Marketing strategies

4. Capital

Here the lenders will look at your assets and consider:

• The amount of your assets and liabilities
• The type and liquidity of your assets and liabilities

In your loan application they will want you to address:

• Are you in a strong enough financial position?
• Could you sell your assets if you needed to reduce debts and how long would it take?

You should provide budgeted balance sheets for the next 3 years.

5. Conditions

Here the lenders want to assess that you understand your obligations of the loan you are applying for..

Lenders will consider:

• The loan repayment schedule
• The cost (interest rate and fees)
• Conditions precedent (anything that must happen before funding)
• Conditions subsequent (things that must happen during the loan)

You need to answer these questions in your loan application:

• Do you understand what you may need to give your financier?
• Will you be able to meet all of the conditions of the loan?
• Do you understand what may happen if you ‘breach’ a term of the loan?

You could provide:

• A summary of loan terms and conditions in the loan application
• Budgeted balance sheets for the next 3 years

Common mistakes people make in business loan applications

Before you submit your loan application, check that you haven’t made any of these common mistakes:

• You thought that business turnover is the same as cash received from customers. Banks look at both net profits and cash flows.
• You haven’t provided information about the directors of the business. Banks will assess directors and may ask for guarantees from them.
• You have provided a security which is worth much more than the loan – this makes it harder to provide security on other loans if required.
• You have not included outstanding loans you have with other lenders.
• You have not factored loan repayments into cash flow forecasts.
• You have inflated the value of business assets.

Lastly, before you get cracking on those loan applications, it’s worth considering whether you have any other options that won’t involve debt.

2. Other options

Are you a start-up? Could you obtain some venture capital to get going?

Could you self-fund the need? Especially if it’s a quick stop-gap measure?

Could you offer friends or family a partnership or share in your business in return for equity?

Are you eligible for any grants or government funding or concessions?

Could you get a private investor to contribute in return for a share in your profits and equity? Investors, like business angels, can also provide expertise as well as funds.

What about crowdfunding a business project like a product or prototype?

In 2017 the government introduced Crowd Sourced Equity Funding for startups and SMEs to raise money from the public where investors can invest up to $10,000 a year in a company in exchange for shares. Could this scheme be something for your business? There are specific parameters so research it and get some advice if you’re interested.

Lastly, think outside the box before you take on debt.

Are there other ways of solving the problem without funding?

For example, could you employ freelancers instead of staff? Or reorganise your processes so you can save some money?

It’s a good time to seek financing for a small business as the threshold to eligibility has lowered with the explosion of non-bank lenders and P2P platforms online. While this kind of financing is expensive, its flexibility and ability to address short-term needs that often plague small businesses, are making them increasingly popular.

With any loan product, make sure you have an accurate assessment of the total cost of the loan and be certain your business can manage that cost.

Shop around for the best rates and have all your paperwork ready to go for a smooth application process.

Loan Application Checklist

• Have you decided on your type of finance? Are you sure it needs to be a small business loan?
• What level of debt can your business manage? Prepare a business case and seek the necessary advice to make sure you can service the loan
• What will be the debt term? The term of debt should match the life cycle you are funding
• Do you know how financiers will assess your application according to the 5Cs?
• Have you consulted an advisor?
• Have you shopped around?
• Have you prepared your business case?
• Do you have a personal guarantee?
• Have you prepared all the relevant paperwork?
• Do you understand all the terms and conditions?