Whether you’re starting up, an established small business, or a growing enterprise, understanding business financing and loan terms is crucial when exploring funding options.
From business loans opens in new window arranged with high street banks to equity investment from angel investors opens in new window, it pays to understand terms such as annual percentage rate (APR) and early repayment charge (ERC).
This is so you can be sure about the meaning of the terms of commercial funding agreements, which can help you understand the true cost of funding to your business over the long term.
Understanding additional costs is critical – such as additional fees for paying off a loan early to the impact of any secured assets you have against a secured loan opens in new window in the event of non-payment – to help avoid unexpected surprises linked to funding.
This guide details the types of terms you may encounter when researching funding, including:
- general loan terms – A to Z of terms that your start-up may encounter in the terms and conditions of a commercial loan or funding product
- types of loan terms – A to Z of the types of loans or funding your business may encounter
- financial and funding terms – General A to Z of related financial terms that you may read or hear when discussing funding for business.
General loan terms
A stipulation that, upon certain conditions (such as default), the entire loan amount becomes immediately due and payable.
The process of gradually reducing a loan’s balance over time through regular payments.
An amortisation schedule shows the breakdown of each payment into its principal and interest components.
Annual Percentage Rate (APR)
The APR represents the true cost of borrowing, inclusive of interest and any associated fees.
It provides businesses with a clear comparison between different loan offers.
All lenders in the UK are required to display the APR for their loans.
Interest that accrues and is added to the principal balance instead of being paid off.
This means the borrower will be paying interest on the interest.
Interest is calculated on both the initial principal and the accumulated interest from previous periods.
It can significantly affect the amount a business ends up paying back, especially over longer loan terms.
Conditions or clauses included in a loan agreement that the borrower must adhere to.
They can range from maintaining certain financial ratios to not taking on additional debt.
Failure to meet the obligations of the loan agreement, usually by missing repayments.
Defaulting can lead to penalties, increased interest rates, and potential legal action opens in new window.
Due on demand
A clause that allows the lender to request full repayment of the loan at any time.
Early Repayment Charge (ERC)
Lenders may charge a fee if the borrower repays the loan before the end of the term.
It compensates lenders for potential lost interest.
Event of default
Specific conditions or situations, as defined in the loan agreement, that, if occurring, can lead to the loan needing to be paid back early.
A detailed list of all charges and fees associated with a loan, such as early repayment charges and late payment penalties.
Fixed interest rate
This refers to an interest rate that remains constant over the entirety of the loan term.
Businesses benefit from predictable monthly payments, aiding in financial planning and budgeting opens in new window.
A set period after a payment due date during which a borrower can make a payment without incurring late fees or consequences.
A percentage of a loan or deposit balance that a lender charges as interest to the borrower.
It’s the cost of borrowing or the reward for lending.
A formal document that outlines all terms and conditions of a loan, including the interest rate, repayment terms, and borrower and lender obligations.
A metric representing the ratio between the amount of the loan and the total value of the asset being purchased or used as collateral.
A lower LTV usually indicates less risk for the lender.
The final date by which the borrower must have repaid the loan in full, including both the principal and interest.
Paying off a portion or the entirety of a loan before its scheduled due date.
While this can save on interest, some lenders impose fees for early prepayment.
The original sum of money borrowed, not including any interest or additional fees.
It’s the base upon which interest is calculated.
A plan that details when and how a borrower will make repayments on a loan.
It includes the dates, amounts, and number of instalments.
The agreed-upon period for which the loan is provided.
At the end of the term, the loan should be fully repaid unless it’s refinanced.
Variable interest rate
Unlike the fixed rate, a variable interest rate fluctuates, typically in tandem with the Bank of England’s base rate.
Monthly repayments may vary, making it essential for businesses to be prepared for potential increases.
Types of loan terms
This refers to a loan used to purchase tangible assets, such as equipment or vehicles.
The asset itself often serves as collateral for the loan.
Short-term financing used by businesses to ‘bridge’ a gap between payments or funding.
Often used in property purchases or while awaiting approval for longer-term financing.
Rather than borrowing money, a business raises capital by selling shares or equity opens in new window.
This doesn’t require repayment like a loan but dilutes the ownership of your start-up in exchange for funding.
A loan where another individual or entity guarantees to repay the loan if the borrower defaults.
The guarantor assumes the risk and responsibility of the loan.
A loan where the borrower only pays the interest for a predefined period, after which they begin repaying the principal.
This can reduce initial repayments but might result in larger total payments.
A method where businesses use unpaid invoices to gain advance funds from a lender.
The lender typically pays a percentage of the invoice, and once the customer pays, the remaining balance (minus fees) is settled.
Peer-to-peer (P2P) lending
An alternative lending method where businesses borrow money from individual investors rather than traditional financial institutions.
It typically occurs through online platforms.
Revolving credit facility
A flexible financing method where businesses can draw down, repay, and redraw money opens in new window.
It’s similar to a credit card but designed for businesses.
A loan that requires the borrower to provide collateral or assets as security opens in new window.
If the business fails to repay the loan, the lender may claim this collateral to recoup the outstanding amount.
A loan with a fixed tenure or term during which it must be repaid.
Depending on the agreement, monthly repayments, and interest rates can be either fixed or variable.
Loans offered without needing collateral.
They typically come with higher interest rates due to the increased risk to the lender, especially if the borrower defaults.
Working capital loan
A short-term loan designed to finance the daily operations of a business opens in new window, such as payroll or rent, rather than long-term investments or assets.
Financial and funding terms
The transfer of rights or interests from one party to another, typically when selling the loan to another party.
A tangible asset or property that a borrower offers to a lender as security for a loan.
If the borrower defaults on loan repayments, the lender can seize the collateral and sell it to recover their money.
A numerical representation of a business’s (or individual’s) creditworthiness.
It’s based on credit history opens in new window, and lenders often use it to evaluate the risk of lending to a business.
The process of taking out a new loan to repay multiple debts.
Businesses often use this to simplify their financials, benefit from better terms, or improve their cash flow opens in new window.
The act of accessing or “drawing down” funds from an agreed loan facility.
Not all loan types offer multiple drawdowns.
An individual or entity that guarantees to pay back a loan on behalf of the primary borrower, should they default.
They essentially “vouch” for the borrower.
A legal claim or right on assets used as collateral, ensuring payment of the loan.
If the borrower defaults, the lender can enforce the lien and take possession of the asset.
Material Adverse Change (MAC)
A substantial negative change in the borrower’s ability to repay the loan.
If a MAC occurs, the lender might have the right to call the loan or change its terms.
A commitment by an individual, often a business owner, to personally pay back a loan if the business cannot.
It merges personal and business finances and represents an increased risk for the guarantor.
The process of replacing an existing loan with a new one, usually with different terms or a better interest rate.
Businesses often refinance to take advantage of improved financial circumstances or market conditions.
The French word for ‘slice’, tranche means to divide something into smaller segments, especially money.
Simply put, a tranched loan allows you to borrow part of the amount your bank has agreed to lend to you now, with the rest (if you need it) to follow at a later date.
Certain financial products, such as a Start Up Loan opens in new window, allow you to do this.
The process lenders use to evaluate the risk of lending to a business.
It involves assessing the company’s financial health, credit history, and the market in which it operates.
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Reference to any organisation, business and event on this page does not constitute an endorsement or recommendation from the British Business Bank or the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circumstances and, where appropriate, seek professional or specialist advice or support.