Sole Trader Loans: What You Should Know
In this blog post, we’ll explore the world of business loans, in particular focusing on sole trader loans.
I have already shared plenty of information in my article on how to get a quick loan for your business but this time I want to spend some more time defining some other important aspects.
- Definition of Sole Trader
- Why Sole Traders Ask for Loans
- The Different Types of Loans for Sole Traders
- Credit Broker vs. Lender: Understanding the Difference
- How to Obtain a Sole Trader Loan
- The 8 Phases to Get a Business Loan for Sole Proprietor
- How Long it Takes to get a Loan for Sole Proprietor
What is a Sole Trader?
A Sole Trader also known as a “Sole Proprietor” or “Sole Proprietorship”, is a form of business structure operated by a single individual who also owns his business.
The main difference from a corporate Ltd is that in this business form, the owner is personally responsible for all aspects of the business, like profits, debts, and mostly liabilities.
Sole Traders have complete control over decision-making in opposition to what would happen in a company and they have the privilege to retain all the profits generated by the business.
On the other flip of the coin, though, they are also liable for any losses or debts incurred by the business itself.
To make it simple, the sole trader is considered all in one with the business in the eyes of the law. The owner and the business are not considered separate legal entities.
This detail makes it one of the easiest and most common ways to start and operate a small business. However, it also means that the sole trader is personally exposed to unlimited financial risks and liabilities related to the business.
Why a Sole Traders ask for Loans?
As explained just above, Sole Traders are nothing but business owners that have to either sustain expenses or invest capital in expanding their activity. There are plenty of cases for which sole traders can require a loan for example:
- Expansion and Growth: As a business grows, it may require funds to expand its operations, open new locations, or diversify its product or service offerings. A loan can finance these expansion plans and help the sole trader take advantage of new opportunities
- Equipment and Asset Purchases: Investing in new or upgraded equipment can improve productivity and efficiency. A loan for purchasing equipment or assets can spread out the cost over time while allowing the sole trader to benefit from the investment immediately.
- Dealing with Emergencies: Unexpected events like equipment breakdowns, natural disasters, or unforeseen expenses can disrupt business operations. A loan can provide the necessary funds to handle such emergencies and keep the business running smoothly.
The Different Types of Loans for Sole Traders
Since necessities and terms are different is important to specify the most common types of loans available in the market:
Unsecured Business Loans: These are particular types of loans where you as a borrower, are not required to give collateral (which is nothing but a security that the lender can eventually obtain to sell and recover the borrowed amount. They are based on the sole trader’s creditworthiness and business performance. Usually, they are typically quicker to obtain but they come with higher interest rates.
Secured Business Loans: Secured loans require collateral. What can be used as collateral will depend on the amount borrowed but the most common collaterals are property, equipment, or inventory. They often come with lower interest rates due to reduced risk for the lender (a screening process is usually performed).
Short-Term Business Loans: Coming with a shorter repayment term, they range from a few months to a year. Usually accessed to cope with temporary cash-flow gaps or cover immediate business needs.
- Long-Term Business Loans: Long-term loans have extended repayment periods, from several years to a decade. This is the most common choice when it comes to funding investments or expansions.
Other Different Forms of Loans
Finally, there are also other different forms of loans and borrowings for sole traders which are:
Equipment Financing: This type of loan allows the sole trader to purchase or lease equipment for their business. The equipment itself serves as collateral for the loan.
Invoice Financing: Also known as invoice factoring or accounts receivable financing, this option allows the sole trader to get immediate cash by selling their outstanding invoices to a lender at a discount.
Merchant Cash Advance: This form of financing provides a lump sum payment in exchange for a percentage of the sole trader’s future credit card sales. Repayments are made through a fixed percentage of daily sales.
Personal Loans: In some cases, a sole trader may opt for a personal loan to finance their business needs. However, this mixes personal and business finances, and it’s essential to consider the risks involved.
Business Credit Cards: While not a traditional loan, business credit cards can be a convenient way for sole traders to access short-term funds and build credit for their business.
Credit Broker vs. Lender: Understanding the Difference
Before you move on with asking for a Sole Trader Loan you have to understand the difference between these two entities.
Nothing but a middleman that connects the borrower (you) to the lender (f.e. Bank).
They work independently and they are not the ones providing the actual funds. Usually they are the ones doing the dirty job of performing due diligence activities and assisting during the application. In exchange, they get a fee if the loan gets signed
These are the guys with cash in abundance happy to “invest” in you in exchange for interest in a short or long-term window. Banks, financial institutions, credit unions, and online lenders all belong to this category.
They might or might not do their due diligence but surely they do two things: disbursing funds and collecting repayments.
How to Obtain a Sole Trader Loan
As a sole trader, you can apply for sole trader loans to finance your business requirements or cope with any of the possible events where you are asked to get your hands on a lump sum.
Always evaluate whether to submit your application to a Broker (and maybe get a better interest rate) or go directly to a lender but in general, this is what the process involves:
- You’ll be going through a Personal Credit Assessment: Since sole traders and their businesses are treated as one legal entity, lenders will base their decisions on your personal credit history. For this make sure to have a high Credit Score.
- They will evaluate your Business Stability and Performance: If your business demonstrates consistent income and growth along with a good balance sheet you are more likely to be successful with your loan application.
- You will have to provide documents like Tax returns and financial statements: In theory, you should have these documents at hand at all times. These documents represent the main key metric to evaluate your repayment capacity.
The 8 Phases to get a Business Loan for Sole Proprietor
When asking for a Business loan for Sole Proprietor, the application will follow some rigorous procedure. to make it easier for your I have grouped the process in 8 phases, each one with its steps.
Whilst this give you a better overview, consider the fact that each lending company has its specific tailored process when it comes to providing a business loan for Sole Proprietorship. However, the steps should be more or less the same.
Phase 1: Application Submission and Verification
- Document Verification: Lenders will review the application form and supporting documents submitted by the borrower to ensure they are complete and accurate.
Phase 2: Credit and Financial Assessment
- Personal Credit Check: Lenders assess the borrower’s personal credit history, including credit score and credit report, to gauge their creditworthiness.
- Business Credit Check: If applicable, lenders may also review the business’s credit history and score.
- Debt-to-Income Ratio: Lenders evaluate the borrower’s debt-to-income ratio to understand their existing financial obligations.
Phase 3: Business Evaluation
- Business Stability and Performance: Lenders assess the stability and performance of the borrower’s business. This includes analyzing financial statements, cash flow, revenue trends, and profitability.
- Business Plan: If provided, lenders review the borrower’s business plan to understand the goals, strategies, and projected outcomes of the business.
Phase 4: Collateral Assessment and Evaluation(if Applicable)
- Collateral Evaluation: If the loan requires collateral, lenders assess the value and quality of the proposed collateral to determine its suitability as security for the loan.
Phase 5: Loan Purpose and Repayment Capacity:
- Loan Purpose Suitability: Lenders analyze whether the intended use of the loan aligns with the borrower’s business needs and financial objectives.
- Cash Flow Analysis: Lenders review the borrower’s cash flow to determine if it’s sufficient to cover loan payments while managing other business expenses.
- Debt-Service Coverage Ratio (DSCR): Lenders calculate the DSCR to assess the borrower’s ability to meet debt obligations. A higher DSCR indicates better repayment capacity.
Phase 6: Risk Assessment and Decision Making
- Collateral Appraisal: If the collateral is involved, lenders may conduct a professional appraisal to determine the value of the collateral being offered.
- Risk Evaluation: Lenders assess the overall risk associated with lending to the borrower. This includes considering factors such as credit risk, industry risk, and economic conditions.
- Lending Criteria: Lenders compare the borrower’s application and financials against their internal lending criteria to determine if the applicant meets the requirements for loan approval.
- Lending Committee (if applicable): In some cases, larger loans or more complex situations may require approval from a lending committee within the lender’s organization.
Phase 7: Loan Structuring and Offer:
- Loan Terms and Conditions: If the loan is approved, the lender structures the loan by specifying the terms, interest rates, repayment schedule, and any associated fees.
- Loan Offer: Lenders provide the borrower with a formal loan offer, outlining all the terms and conditions of the loan.
Phase 8: Borrower Acceptance and Due Diligence:
- Review and Acceptance: The borrower reviews the loan offer, including all terms, and decides whether to accept it.
- Further Verification: In some cases, lenders may perform additional due diligence, such as verifying business assets, conducting background checks, or seeking clarifications on the provided information.
- Final Approval: Once all due diligence is complete, the lender provides final approval for the loan.
- Funds Disbursement: The lender disburses the approved loan amount to the borrower’s designated account.
How Long it Takes to Get a Business Loan for Sole Proprietor
As you might have guessed, there is no exact answer to this. Every business venture has its own history. And the same applies to Lenders and whether or not you are using a credit broker.
Moreover, efficiency and delays are also depending on you. The process involves submitting various documentation and some of them are not easy to get. However, even if we can still give an estimate on how long this process would take considering that you have everything you are supposed to submit ready and in order.
Here is what it could look like:
- Application Submission and Verification: 1-2 days
- Credit and Financial Assessment: 1-2 days
- Business Evaluation: 1-2 weeks
- Collateral Assessment: If applicable, 1-2 weeks
- Loan Purpose and Repayment Capacity: 1-2 days
- Risk Assessment and Decision Making: 1-3 weeks (including potential lending committee approval)
- Loan Structuring and Offer: 1-2 days
- Borrower Acceptance and Due Diligence: 1-2 weeks (if additional due diligence is required)
Getting your business loans approved can sound complicated, and as a business owner, it is your duty to understand the various options available in the market.
It doesn’t matter if you are a sole trader seeking extra money to expand or acquire a business. Remember that is vital to obtain the right financing to cope with your business needs. Only through proper preparation and research, you will increase your chances of getting the funds required to keep up with your activity as an entrepreneur.
Always remember to compare different lenders, loan terms, and interest rates before making a final decision. By making informed choices, you can ensure the financial success and growth of your business.
Finally, the British Business Bank has a list of the Certified Lenders in the UK (Disclaimer: Always perform your due diligence on what you see in this link also because the names on the list might vary from time to time).