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Business Loans for Sole Traders – Overcoming the Challenge of Getting a Business Loan

business loans for sole traders

If you are a sole trader, getting finance can be difficult and requires you to show that you can repay what you have borrowed. To give you a clearer picture of what’s available for sole traders and what you need to do, we take a detailed look at business loans for sole traders.

Challenges for sole traders wanting business loans

Having your own business and operating as a sole trader can be challenging, especially in the early days. Besides completing your day-to-day work, you have to oversee all aspects of the business, including marketing, staffing, customer service, purchasing and bookkeeping. Another challenge that comes up is finance. Unfortunately, many lenders view sole traders as potentially a big risk when deciding whether to approve business loans. 

What lenders look for when considering business loans for sole traders

In general, when deciding to make a loan to a sole trader, or anyone else, banks and other lenders look at what is called the 5 Cs – character, collateral, capacity, capital and conditions.

Character

When considering business loans for sole traders, banks and other lenders look at your financial history, including your savings, loan repayments, years in business and your credit score. They examine your ability to repay debts on time, if you are able to save, the stability of your income and cash flow, and if you have had defaults, bankruptcies or other legal actions against you. If you have had issues with any of these in the past, it’s a negative reflection on your ability to repay any future loans. When looking for business loans for sole traders, consider how you will rank against the character elements mentioned above.

Collateral

Collateral includes the assets a sole trader has for securing a business loan in case of default. Examples include residential or commercial property, land, vehicles and other personal possessions. The bank or non-bank lender will consider how suitable your assets are as collateral, including the location, condition and the ability to sell the assets if needed. You will want to consider the value, condition and liquidity of your assets before you apply for a business loan. Note that collateral only applies to what are called ‘secured’ loans. You can still get a loan without collateral, but you may have to pay a higher interest rate and not be able to borrow as much. 

Capacity

When determining the ability to repay, lenders will look at several factors, such as sole trader’s income, existing debts, living expenses and the number of dependents. Before applying for a sole trader business loan, consider if you can repay, how stable your revenue is and what you can do if your situation changes.

Capital  

When assessing capital, the lender looks at the sole trader’s overall financial position, including the types and liquidity of assets and the nature of liabilities. The lender will consider your financial position and whether you would be able to liquidate assets quickly enough if meet your obligations if business conditions change.

Conditions

Conditions are determined by the lender and include the repayment schedule, the interest rates and fees, and any conditions that need to be met during the life of the loan and before the loan is granted.  As a sole trader, consider whether you will be able to meet the loan conditions outlined and the outcomes if you unable to meet them.

Types of business loans for sole traders

Before we go over the business loans for sole traders, we need to look at the broader category the loans fall into. These are secured and unsecured business loans.

Secured loans

With a secured business loan, the borrower pledges some type of asset as collateral. This can be residential or commercial property, machinery, plant and equipment, or vehicles. If you are unable to repay the business loan, the assets will be sold to pay what you owe.

Unsecured loans

With unsecured business loans, you don’t pledge any assets as collateral. However, you could still be personally liable, and the lender could have recourse to your assets if the loan is not repaid.

Now that we’ve explained the main distinction in business loans for sole traders, let’s look at the types of business loans available, and their pros and cons.

Bank term loan

This is probably the most difficult type of loan for a sole trader to get, so we will get it out of the way first. In fact, SME research from 2017 showed that banks rejected around 75% of term loan applications from small to medium businesses in Australia. Getting a term loan requires that you provide a large amount of documentation and the approval process can take up to two months.

If you are able to get a bank term loan, you will make regular payments for the term of the loan so there are no surprises about what you will pay and when you will pay it. Unlike other business loans for sole traders, a bank term loan doesn’t offer much flexibility.

Business line of credit

With a business line of credit, a bank will give you access to a predetermined amount of funds – from $10,000 to $1 million. You only pay interest on what you draw from the line of credit. A regular minimum repayment is required and the term for a business line of credit can go up to 10 years. For a business line of credit, lenders usually require property or equity in property as security, and will want to see business financial statements. They will also want to see your credit report to ensure you have a strong credit history. Learn more in What Is a Business Line of Credit?

Business overdraft

If you have been in business for a while, and have a good credit record, a business overdraft is one of the easiest business loans for sole traders to obtain. A business overdraft is linked to your business transaction account and you basically run a negative account balance on your account when you borrow. You only pay interest on the amount you borrow and don’t need to make regular repayments. In addition to interest, there is a set-up fee and ongoing fees with a business overdraft. The amount of a business overdraft can range from $10,000 to $50,000 if it is unsecured.  Secured business overdrafts can have a much higher credit limit.

Besides the fees, one of the shortcomings of business overdrafts is that they can be called in at any time. This means you would need to pay the amount outstanding, regardless of your financial position.

Invoice finance

Also called ‘invoice discounting’, with invoice finance you get a revolving line of credit (usually up to 80% of outstanding invoices) by using your invoices as collateral. For an established sole trader with substantial outstanding invoices, invoice finance could be a viable option. Like an overdraft or line of credit, interest is only paid on the funds borrowed.

The main shortcoming of invoice finance is the high cost compared to other sole trader business loan options. Learn more in What Is Invoice Finance?

Business credit cards

Business credit cards can meet your short-term finance needs as a sole trader. When applying the lender will check your credit score and you are not required to submit a large amount of documentation as with other loans.

There’s a range of business credit cards available to meet your needs. You can get a business credit card that offers rewards, such as frequent flyer points, or a simple card without all the bells and whistles. Most credit cards offer an interest-free period (typically 55 days) for new purchases, so it could be a cost-effective way to meet short-term cash flow needs. One major shortcoming of business credit cards are the interest rates, which can reach over 20%.

When choosing a business credit card, be sure to check the interest rate and understand the terms and conditions, including all the additional fees that can apply.

Buy now, pay later for business

More businesses are turning to this form of finance to buy goods and services. With buy now, pay later, you can pay back the amount over the agreed term. Some of these services a scheduled payments. Others offer more flexibility. With Moula Pay, for example, no interest is accrued or payments are required during the first three months. After three months, you get nine months to pay the balance with an interest rate of 3 per cent on the amount outstanding. Learn more in Buy Now, Pay Later for Business: What Are the Benefits?

Unsecured business loans

Unsecured business loans are a popular alternative for sole traders. In recent years, financial technology companies (fintechs) have streamlined the application process so that much of it can be done seamlessly online. As part of the process, your recent bank transactions are safely and securely analysed online to determine your suitability for an unsecured business loan. In addition, your credit report plays a role in the approval process. By effectively combining technology and people, online lenders such as Moula can provide an answer within 24 hours. If the loan is approved, the funds are transferred immediately into the borrower’s account.

Unsecured business loans typically range from $5,000 to $250,000 (up to $250,000 with Moula) with terms of 0.5 to 2 years. The interest rates are higher than for other forms of finance, but with a shorter term, the overall interest paid can be lower compared to a longer-term loan with a lower interest rate. Find out more about unsecured business loans from Moula

For a comprehensive overview of business finance options, read the Complete Guide to Business Loans in Australia.

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Business content for Australian SMEs. Sharing guides, growth hacks, and expert tips on finance, sales and marketing, and tech.

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