The right type of business finance depends on what you need the money for. Term loans suit one-off investments repaid over a set period, overdrafts and revolving credit cover short-term cash gaps, asset finance spreads the cost of equipment or vehicles, and invoice finance releases cash tied up in unpaid customer invoices. Matching the product to the purpose usually matters more than chasing the headline cost.
This guide draws on the British Business Bank's free, impartial Finance Hub and puts five common forms of debt finance side by side.
Why does the type of finance matter?
Different products are designed for different jobs. Long-term borrowing for a temporary cash gap means paying interest for years on money you needed for weeks. Ask three questions:
- What is the money for? A specific purchase, a growth project, or day-to-day working capital?
- How long do you need it? Weeks, months or years?
- What can you offer as security? Property, equipment, unpaid invoices, or nothing at all?
What is a term loan?
A term loan is the most familiar type of business borrowing. You receive a lump sum and repay it, with interest, in regular instalments over an agreed period. Term loans are often used for planned investments such as refurbishing premises, launching a new product or buying another business.
Business loans can be secured or unsecured. A secured loan is backed by an asset the lender can claim if you do not repay. The British Business Bank notes that secured loans are generally cheaper than unsecured ones, because the lender takes on less risk, although arranging them can take longer. With unsecured borrowing, lenders often ask the directors for a personal guarantee and will look closely at credit history.
Lenders typically want to see a trading history and evidence that the business can afford the repayments, which can make term loans harder to obtain for very young businesses.
How does a business overdraft work?
An overdraft is a line of credit attached to your business current account. It lets you go below zero up to an agreed limit, and you pay interest only on the amount you are actually using. That makes it a convenient buffer for uneven cash flow, such as paying suppliers before a large customer pays you.
There are trade-offs. Overdrafts generally carry higher interest rates than loans, there may be arrangement or renewal fees, and the bank can usually ask for the overdraft to be repaid at any time. An overdraft is best treated as a short-term safety net rather than a permanent source of funding.
What is asset finance?
Asset finance helps you acquire equipment, machinery, vehicles or technology without paying the full cost upfront. The asset itself normally acts as security, which can make this type of finance easier to arrange than an unsecured loan. The two main forms are leasing and hire purchase, and the key difference is ownership:
- Leasing works like a long-term rental. The finance company owns the asset and you pay to use it over a fixed or minimum term. At the end you may be able to continue renting, return it or upgrade it.
- Hire purchase is a credit agreement. You usually pay a deposit and then fixed instalments, and ownership normally passes to you once the final payment is made.
The British Business Bank points out that assets which lose value quickly, or which you expect to upgrade often, tend to be better suited to leasing, while hire purchase suits items you plan to keep for longer. As with any secured finance, missing payments can lead to the asset being repossessed.
How does invoice finance release cash?
If your customers pay on 30, 60 or 90-day terms, a large part of your money can be sitting in unpaid invoices. Invoice finance lets you borrow against those invoices so you receive most of their value sooner. It comes in two main forms:
- Factoring: the provider manages your sales ledger and collects payment from your customers, so customers will usually know you are using it.
- Invoice discounting: you keep control of your own credit control and collections, and the arrangement is often confidential.
Costs typically combine a service fee, often a percentage of invoice value, with a discount charge that works like interest. It mainly suits businesses selling to other businesses on credit terms.
What is a revolving credit facility?
A revolving credit facility gives you access to an agreed credit limit that you can draw on, repay and draw on again during the life of the facility. In that sense it is similar to an overdraft, but it is not tied to your business bank account, so it can come from a different lender.
According to the British Business Bank, you typically pay interest only on the funds you have drawn, but this flexibility can come at a higher overall cost than some other options, and there may be set-up fees and personal guarantees. Revolving credit is usually aimed at limited companies rather than sole traders and is not designed for long-term funding needs.
How do the five options compare?
| Finance type | How it works | Typically used for | Security | Points to watch |
|---|---|---|---|---|
| Term loan | Lump sum repaid in instalments over a fixed period | Planned investments and growth projects | Secured or unsecured; personal guarantees common on unsecured loans | Fixed repayments regardless of cash flow; needs trading history |
| Overdraft | Credit limit on your current account; interest on the amount used | Short-term cash flow gaps | Often unsecured; guarantees may be requested | Usually higher interest than loans; can be withdrawn at short notice |
| Asset finance | Lease or hire purchase of a specific asset | Equipment, machinery, vehicles, technology | The asset itself | Asset can be repossessed if payments are missed |
| Invoice finance | Borrow against unpaid customer invoices | Working capital for B2B firms with credit terms | Your sales ledger | Service fees plus discount charges; factoring is visible to customers |
| Revolving credit | Draw, repay and redraw up to a set limit | Fluctuating short-term working capital | Varies; guarantees possible | Can cost more overall; not for long-term needs |
How should you choose between them?
Before approaching any provider, prepare:
- A clear purpose and amount, ideally costed.
- Up-to-date accounts and cash flow forecasts showing repayments are affordable.
- A view on security, including whether you would give a personal guarantee.
- A total cost comparison covering fees and early repayment charges, not just the interest rate.
It is also worth checking whether a government-backed scheme is available through an accredited lender. The British Business Bank's Growth Guarantee Scheme, for example, supports a range of products including term loans, overdrafts, asset finance and invoice finance. The government guarantee is given to the lender, not the borrower, so your business remains fully liable for the debt.
Frequently asked questions
Is a secured loan always cheaper than an unsecured one?
Not always, but generally. Because the lender can recover its money from the asset you provide as security, it takes on less risk and can often offer better terms. The trade-off is that you could lose that asset if you cannot repay.
Can a new business get finance?
It can be harder, because many lenders look for a trading history. Asset finance may be easier to arrange because the asset provides security, and the government-backed Start Up Loans programme is aimed specifically at people starting or in the early years of a business.
What is the difference between an overdraft and revolving credit?
Both let you borrow, repay and borrow again up to a limit. An overdraft is linked to your business current account with your bank, while a revolving credit facility is a separate arrangement that can be provided by a different lender.
Will my customers know if I use invoice finance?
With factoring, usually yes, because the provider collects payments from them. With invoice discounting you keep handling collections yourself, so the arrangement is often confidential.
Sources
- British Business Bank: Finance Hub
- British Business Bank: What are leasing and hire purchase?
- British Business Bank: What is a revolving credit facility?
- British Business Bank: Invoice finance
- British Business Bank: Growth Guarantee Scheme
General information only, not financial, tax or legal advice. Finance is subject to status and each lender's own criteria, and no rate or approval is implied. Speak to a qualified adviser or your lender before making borrowing decisions.