Short-term business loans: how they work and what to watch

A short-term business loan is a sum of money you borrow and repay over a short period, usually in regular instalments. There is no official cut-off, so this guide uses a working definition of two years or less. That is our line, not a legal or regulatory one.

The British Business Bank describes a term loan as a loan, secured or unsecured, with a predetermined repayment schedule, typically spread over several months or years. A short-term loan is a term loan at the short end of that range. You borrow a set amount, agree how and when to repay it, and the loan ends on a known date.

That fixed end date is the point of the product. It suits a need that is clear and time-limited, such as a stock order that will be sold within months. It is a poor fit for something that will take years to pay for itself.

A short-term business loan works by paying you a lump sum, which you repay with interest and any fees on an agreed schedule until the balance reaches zero. The two common schedules are fixed instalments and repayments that move with your sales.

• Fixed instalments: the same amount each month, or each week, for the whole term. This is the conventional term loan.
• A share of sales: the lender takes an agreed percentage of your takings, so repayments rise and fall with trade. This is how revenue finance and a merchant cash advance are structured.

Fixed instalments are easier to budget for, because you know every payment in advance. A sales-linked repayment is more forgiving in a quiet month, but the total cost can be harder to see at the start, so ask for the full amount repayable in pounds before you agree.

The British Business Bank also notes that each term loan needs a fresh application, which can lengthen the process. If you will need to borrow again, an agreed limit you can reuse, such as a revolving credit facility, may suit better.

Short term usually means somewhere between a few months and two years, and how much you can borrow depends on your business, not on a standard limit. The British Business Bank says the maximum is set by factors such as your industry, what the loan is for and the state of your finances.

The Growth Guarantee Scheme gives one official reference point. Its term loans run from three months up to six years, and the minimum for a term loan is £25,001. The scheme backs lenders, so not every lender offers it and the borrower stays fully liable for the debt.

A short-term business loan is used for day-to-day costs and defined one-off needs that the business expects to cover from future income within the term. The British Business Bank lists payroll, inventory, squeezed cash flow from late customer payments, a sudden rise in bills and a sudden expansion opportunity.

The common thread is a gap in timing, not a hole in the accounts. If the money will come back in from sales or from customers within the term, a short loan can bridge the wait. Our guide to working capital loans covers that use in more detail.

A forecast makes the difference between a sensible loan and a hopeful one. Before you borrow, map when money leaves and arrives using a cash flow forecast, and check that the repayments fit inside it.

A short-term loan costs the interest, the fees and any charges for repaying early, and the number to compare is the total amount you will repay. The British Business Bank defines APR as the rate of interest you agree to pay on money borrowed, a useful way to compare providers, and notes that the higher the APR, the more you will pay.

APR has limits on short loans. It is an annual figure, and a loan lasting a few months can show a large annual rate while costing a small number of pounds, or the reverse. Read how APR works and always set it beside the total repayable.

That illustration uses round numbers to show the sum. It is not a typical cost, a benchmark or a rate any lender charges. What matters is that you can do the same sum with a real offer.

• Arrangement or other fees, and whether they are deducted from the amount you receive
• Charges for repaying early, if the agreement has any
• Whether repayments are weekly, monthly or tied to sales
• Late-payment charges and what default allows the lender to do

A short-term loan can be secured on an asset or unsecured, and unsecured loans often come with a personal guarantee from a director. The British Business Bank says unsecured loans do not require an asset as collateral but lenders typically ask for a personal guarantee as assurance of repayment.

A secured loan is backed by property or other assets you own, and failing to repay could mean losing the asset. A guarantee makes you personally liable if the business cannot pay. Read how personal guarantees work before you sign, and take independent legal advice.

Lenders may look at your trading position, credit history, cash flow, balance sheet and cash reserves. Our guide to unsecured business loans explains that route.

Most business lending is not regulated by the FCA, but some is. The FCA says its remit covers business lending of £25,000 or less to sole traders and small partnerships, but not to limited companies, and business lending above £25,000 generally falls outside it.

The legislation uses the same line. A credit agreement for business purposes is exempt where the credit exceeds £25,000. In practice, a £20,000 loan to a sole trader may be regulated, while the same loan to a limited company is not. Capzy does not give legal advice, so ask a solicitor if the status of a specific agreement matters to you.

The main alternatives are products that match the shape of your cash gap more closely than a lump sum does. The right one depends on whether the gap is one-off, recurring or caused by slow-paying customers.

Our guides to invoice finance and business overdrafts set out how those options work.

A short-term loan is the wrong choice when the money will not come back within the term, because short repayments are large relative to the amount borrowed. Cover for ongoing losses, or an investment that pays back over years, strains cash flow under a tight schedule.

If the need is for something long-lived, such as equipment or premises, our guide to long-term business loans covers borrowing over a longer period.

Capzy is a credit broker, not a lender, and is paid by the lender. We introduce businesses to lenders that offer term loans and short-term finance and set out what comes back so you can compare it, including through the lender directory.

You can check your funding options with a soft search that does not affect your credit score. A full application to a lender may involve a hard search, and any offer is subject to status and lender criteria. For a side-by-side view of offers, read how to compare lenders.