Business loans and other forms of debt finance allow companies to raise capital without giving up ownership in the business.
Instead, a lender provides funding that the business agrees to repay, normally with interest, over an agreed period.
Debt financing can be used for everything from improving working capital and purchasing equipment to expanding into new locations or business funding for buying a business.
However, taking on debt creates an ongoing financial commitment, so it is important to understand how business loans work, the different forms of debt funding available and what lenders will consider before agreeing finance.
This guide explains debt finance for UK businesses, including the main types of business loans, how repayments work, secured and unsecured borrowing, costs and when debt funding may be appropriate.
Debt finance is money borrowed by a business that must be repaid to the lender according to agreed terms.
The business receives capital upfront or access to an agreed facility and usually pays:
Unlike equity finance, the lender does not normally receive shares in the business.
This means the existing owners can retain their ownership, but the company must continue meeting its repayment obligations.
Common forms of debt finance include:
Debt and equity are the two broad categories into which most external business finance falls. With debt, capital is borrowed and repaid. With equity, capital is raised by giving an investor an ownership stake in the business.
A business loan is a form of debt finance where a lender provides money to a business and the borrower repays it over an agreed period.
Repayments normally include both:
Capital – the amount originally borrowed.
Interest – the cost charged by the lender for providing the finance.
For example, if a business borrows £100,000, it will usually repay more than £100,000 over the life of the loan once interest and any fees are included.
Business loans can be:
The precise structure depends on the lender, the business and what the funding is being used for.
Business loans are relatively flexible and may be used to fund:
The purpose of the funding will influence which type of business finance is most appropriate.
For example, a five-year business loan may make sense for a long-term expansion project, whereas a revolving credit facility may be better suited to a temporary working capital requirement.
A typical debt finance arrangement follows several stages.
The company works out:
For example, an established company may decide it requires £300,000 to purchase equipment and increase production capacity.
The lender will assess the company and the proposed use of the funding.
This could involve reviewing:
The lender needs to be confident that the business can support the proposed financial commitment.
A profitable company does not automatically qualify for borrowing.
The lender will also look at whether sufficient cash is generated to make repayments.
If the application is approved, the lender may set out terms including:
Depending on the product, the money may be provided as a lump sum or made available through a flexible facility.
The business then makes repayments according to the agreement.
Failure to meet those obligations can have serious financial consequences and may allow a lender to enforce security or guarantees where applicable.
Debt funding is broader than a conventional business loan.
Different products are designed for different commercial needs.
A term loan provides a fixed amount of money that is repaid over a set period.
For example:
Loan amount: £250,000
Term: 5 years
Repayment: Monthly
Interest: Fixed or variable depending on the agreement
Term loans are commonly used for:
They can provide certainty because the repayment period is agreed in advance.
An overdraft allows a business bank account to fall below zero up to an agreed limit.
Unlike a term loan, the business normally only uses the amount it needs.
This can make overdrafts useful for:
They are generally better suited to short-term requirements than funding major long-term investments.
A revolving credit facility allows a business to borrow, repay and borrow again up to an agreed limit.
It works differently from a conventional term loan because the entire amount does not necessarily need to be drawn at once.
For example, a business could have a £500,000 facility but only use £150,000 when additional working capital is required.
As the money is repaid, the facility can potentially be used again during the agreed term.
Asset finance is debt funding linked to assets such as:
Instead of paying the full purchase price upfront, the cost is spread over an agreed period.
Asset finance can help preserve working capital while still allowing the company to invest in assets required to operate or grow.
Read Asset Finance: How It Works for UK Businesses for more information.
Invoice finance allows eligible businesses to raise funds against unpaid customer invoices.
This can be particularly useful where there is a substantial delay between completing work and receiving payment.
Common types include:
Invoice finance is primarily a working capital and cash flow tool rather than a conventional lump-sum loan.
Read Invoice Finance: Factoring and Invoice Discounting Explained for a full guide.
Working capital finance is designed to support the everyday operating requirements of a business.
It can help fund:
Working capital facilities may be structured as loans, overdrafts, revolving credit or other forms of finance.
Read Working Capital Finance: Funding Day-to-Day Business Needs for more information.
Debt finance can also be used to help buy an existing business.
An acquisition lender may assess the financial performance of the target company as part of the funding decision.
Relevant factors can include:
Acquisition debt may be combined with other funding sources such as buyer capital, seller finance or deferred consideration.
Read our guide to Debt Funded Purchase: How Does It Work? for a more detailed explanation of using debt specifically to acquire an established business.
Business loans can be either secured or unsecured.
Secured borrowing uses assets or other security to support the loan.
Potential security could include:
Providing security gives the lender additional protection if the company cannot repay the debt.
This may allow larger amounts to be borrowed or different terms to be offered.
However, the assets used as security may be at risk if the borrower fails to meet the agreement.
Unsecured business loans do not normally take security over a specific business asset.
Instead, the lender places greater emphasis on:
Some unsecured loans may still require directors to provide personal guarantees.
Read Secured vs Unsecured Business Finance: Key Differences for a full comparison.
The interest charged on business finance may be fixed or variable.
A fixed rate remains unchanged for the agreed fixed-rate period.
This can make repayments more predictable.
For example, if the business knows its repayment is £4,000 per month throughout a fixed-rate term, this can make cash flow planning easier.
A variable rate can change over time.
The interest rate may be linked to an underlying benchmark or otherwise vary according to the lending agreement.
This means repayments or interest costs may rise or fall during the term.
Businesses using variable-rate debt should consider whether they could still afford the borrowing if rates increased.
There is no universal maximum business loan amount.
The amount available depends on the lender, finance product and strength of the borrower.
Factors may include:
A lender is unlikely to assess borrowing capacity simply as a percentage of revenue.
The key issue is whether the proposed debt can reasonably be supported.
For example, two businesses may both generate £3 million in annual sales.
One may produce £600,000 of EBITDA with limited existing debt, while the other generates £100,000 and already has significant borrowing.
Their debt capacity would be very different.
Read How Much Business Funding Can You Get? for a more detailed explanation.
Business finance providers assess a range of factors.
Lenders may review historic accounts to understand:
Consistent financial performance can give the lender greater confidence in the business.
Cash flow is critical because loan repayments are made with cash rather than accounting profit.
A lender will want confidence that the company generates enough cash to service the debt.
The lender will normally consider how much debt the business already has.
Additional borrowing needs to remain affordable after existing repayments are taken into account.
The financial history of the company, and potentially its directors, can influence both approval and pricing.
Where secured finance is being requested, the lender may assess the value and quality of the assets available as security.
The business should clearly explain why the money is required.
A defined commercial purpose is easier to assess than a vague request for additional cash.
For larger or more complex transactions, lenders may also consider whether the management team has the experience required to deliver the proposed plan.
For more detail, read Business Funding Requirements: What Will You Need to Apply?
The cost of debt finance includes more than the interest rate.
Possible costs include:
A business should therefore consider the total cost of borrowing.
For example, two lenders could offer the same £250,000 loan at different interest rates but with very different fees and repayment terms.
The cheapest headline rate may not produce the lowest overall cost.
Read Business Funding Costs: Interest Rates, Fees and Total Cost for more information.
A lender may ask directors or shareholders to provide a personal guarantee.
A personal guarantee can make the guarantor personally responsible for some or all of the company's debt if the business cannot repay it, subject to the wording of the agreement.
Before agreeing to one, directors should understand:
Independent legal advice may be appropriate before entering into a personal guarantee.
Read Personal Guarantees for Business Funding: What Directors Need to Know for a detailed explanation.
Debt finance can offer several advantages.
Borrowing money does not normally require the owners to give shares to the lender.
This means existing shareholders retain the future value of the company.
With a structured loan, businesses can often forecast repayments and incorporate them into financial planning.
A company may be able to make an investment sooner rather than waiting until it has accumulated enough cash internally.
Businesses can choose from products designed for:
Historic profitability and cash flow can help established companies demonstrate their ability to support borrowing.
Debt also creates risks and obligations.
Repayments usually continue even if trading performance weakens.
The business ultimately pays more than the original amount borrowed.
High repayments can reduce the amount of cash available for operations and investment.
Assets used as security may be at risk if the business cannot repay.
This can potentially expose directors or shareholders to personal financial liability.
Taking on substantial debt now may limit the amount of additional finance available later.
Debt and equity finance solve the same underlying problem — providing additional capital — but they do so in very different ways.
|
Debt Finance |
Equity Finance |
|
Capital is borrowed |
Capital is invested |
|
Usually repaid with interest |
Usually no loan repayment |
|
Owners generally retain shares |
Investor receives equity |
|
Creates cash flow commitments |
Creates ownership dilution |
|
Lender normally has limited involvement in management |
Investor may have governance rights |
|
Debt has a defined financial cost |
Cost can include sharing future business value |
Debt may suit an established business with predictable cash generation that wants to retain ownership.
Equity may suit a business requiring substantial growth capital where fixed repayments would create too much pressure.
Some businesses use a combination of both.
Read Debt Finance vs Equity Finance: Which Is Better for Your Business? for a detailed comparison.
Debt funding may make sense where:
For example, a profitable manufacturer may decide to borrow £300,000 to purchase machinery that increases production capacity.
If the company can comfortably service the finance and expects the new capacity to increase profits, debt may be commercially sensible.
Borrowing may be less appropriate where:
In those circumstances, another form of business funding may be more appropriate.
The precise application process varies by provider, but generally involves:
Understand exactly how much money is needed.
Be clear about what the funding will achieve.
Assess:
This may include:
Not every lender is appropriate for every business or funding requirement.
Review the:
The British Business Bank advises that lenders typically require businesses to demonstrate both the intended purpose of borrowing and their ability to repay it.
For the complete process, read How to Get Funding for a Business in the UK.
A declined loan application does not necessarily mean the business cannot obtain finance from another provider.
Different lenders have different:
However, it is important to understand why the application was rejected.
Common reasons can include:
Applying repeatedly without addressing an underlying issue may not improve the situation.
Some businesses declined by participating major banks may also be offered referral through the UK's Bank Referral Scheme to alternative finance platforms.
Read Why Business Funding Applications Are Rejected for more information.
Debt finance is commonly considered when acquiring an established company because the target business already has a financial history that a lender can assess.
Unlike funding a startup, the lender may be able to review:
This information can help determine whether the target business can support acquisition debt after completion.
A typical transaction might combine:
Purchase price: £1,000,000
The exact funding structure depends on the company, the buyer and the transaction.
Importantly, a lender will not simply provide debt because the purchase price supports the amount requested. The business must be capable of servicing the borrowing after the acquisition.
For a detailed look at this specific funding strategy, read Debt Funded Purchase: How Does It Work?.
You can also read our guide to financing a business purchase for a wider comparison of acquisition funding options.
Business loans and debt finance can give companies access to capital without giving away ownership.
That can make borrowing an attractive way to fund expansion, assets, working capital or an acquisition.
However, debt should only be taken on where the business has a clear reason for borrowing and a realistic ability to meet its commitments.
Before agreeing finance, consider:
The best debt structure is not necessarily the one that provides the largest loan.
It is the one that provides enough capital to achieve the business objective while leaving sufficient financial headroom for the company to operate successfully.
For a broader overview of borrowing alongside equity, grants and other options, read our Business Funding Guide.
If you are considering debt finance because you want to buy an established business, understanding your borrowing capacity can help you identify more realistic acquisition opportunities from the outset.
At Valius, we help buyers find established businesses for sale and navigate the wider acquisition journey, including valuation, due diligence, negotiation, deal structure and funding.
Acquisition debt can allow you to fund part of a purchase without providing the entire price from your own capital. Depending on the opportunity, the overall deal could combine your own investment with commercial borrowing, seller finance or deferred consideration.
The key is finding a business with the financial strength to support the proposed funding after completion.
By exploring opportunities through Valius alongside understanding your likely funding position, you can focus your search on businesses that fit both your acquisition goals and your available capital.
Ready to find a business you could realistically acquire?
Browse Businesses for Sale or Create Your Free Valius Account and start exploring opportunities today.