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Article:

Loans vs Grants

20 November 2019

This article explores the various types of loans and grants available to UK businesses and highlights their relative advantages and disadvantages. Loans and Grants are the two most common ways for businesses to obtain funding. While the two accomplish a similar end result, they are fundamentally different.

Loans

A loan is an arrangement whereby a sum of money is borrowed which is repayable with interest within a certain period of time.

Loans are usually given by financial institutions or commercial banks but are also provided by government bodies. Different loan types carry different interest rates, repayment conditions and durations. The applicant must meet certain qualifications established by the lending institution such as the feasibility of venture being funded. For instance, start-ups will find it harder to secure a loan than larger businesses because they have not yet established a solid financial history.

A loan must be repaid and failing to do so can result in the forfeiture of assets put up as collateral.

Below we explain the different types of loans available and how they may be suited to your business.

Commercial loans

Commercial loans, which are not guaranteed by a government agency, can be conventional bank loans or convertible loans.

Conventional commercial loans usually have a repayment term of 1 to 5 years and interest rates range between 7% and 30% depending on the qualifications provided. Borrowers need to prove satisfying annual revenue and credit score to qualify. They should also have been in operation for at least 4 years.

For borrowers that need funds quickly, conventional bank loans have a faster approval process than other funding options.

Convertible loans are a form of equity financing. They are usually shorter-term debts with a set interest rate and that can be converted into equity. When the loan reaches a pre-agreed maturity period, the lenders/investors, such as hedge funds, can choose to convert it either into shares or cash of equal value.

Convertible loans are often source of “bridge financing” before an anticipated large financing round or when investors and entrepreneurs cannot agree on a valuation. Convertible loans can also be processed faster than an equity investment.

However, until the loan gets converted to equity, the lender/investor has a priority right at maturity date to claim any assets such as cash or hardware. This type of equity financing, along with Venture Capital, will be covered more extensively in following articles.

Government loans

These loans are provided by government bodies, such as local enterprise partnerships (LEPs) and councils, to businesses in order to support private sector growth or to address specific challenges.

Government loans generally have more favourable conditions in terms of repayment duration and interest rate than commercial loans. However, they can be limited to specific geographic areas, industries or types of business. Access to government loans can be competitive and the size of the loan can be limited. Interest rates usually vary based on the borrower’s creditworthiness and collateralisation.

Examples of government loans include the Home Building Fund that offers loans of up to £250 million for residential development with up to 20 years repayment or the Regional Growth loans which usually offer up to £1 million with 5 years maximum repayment period.

Innovation loans

Innovation loans are a separate category of government loans aimed at supporting innovation initiatives. These are offered through loan competitions to UK SMEs that want to scale up and grow by developing new or improved products, processes or services. They can be for late-stage research and development projects that have not yet reached the point of commercialisation.

SMEs need to show that they can afford the interest and repayments on the loan and that they cannot obtain finance from other sources such as banks and equity investors. For example, Innovate UK offers competitive loans of up to £1 million to cover 100% of a project’s eligible costs, with a repayment period of up to 10 years. The current interest rate is 3.7% per year.

Grants

A grant is a form of assistance, monetary or non-monetary, that is non-repayable. There are a wide variety of grant types, providers and competitions for different geographies and project types. Grants are awarded by government bodies (national and international), trusts, educational institutions, not for profit organisations and even corporations. The grants usually aim to promote a public good. Accessing grants can be very competitive and the terms can be relatively restrictive. However, compared to loans they are a risk-free way of obtaining financing.

It is worth noting that grants that are misused may have to be repaid and that many grants require the grantees to find private match funding.

Innovation Grants

Innovation grants are open to all UK organisations including businesses, academics and universities and charities. The recipient must be planning to develop new products, processes or services that are commercially and technically innovative, or improve existing ones through research and development.

Funding is available for projects at various stages - from feasibility studies through to developing and testing a prototype. There are several UK and EU funding bodies that provide innovation grants of up to €10 million including;

  • Innovate UK
  • Department for Business, Energy & Industrial Strategy
  • Defence and Security Accelerator
  • Eureka Eurostars
  • Horizon 2020

The eligibility criteria, scope and amount of funding depend on fund provider, type of project/company and specific competition. Usually, SMEs and earlier stage projects are eligible for higher funding rates of up to 70%.

Regional growth grants

Regional Growth Grants support projects and programmes raising private sector investment to create economic growth and creating or safeguarding sustainable jobs, often in areas or communities affected by economic decline. Grants are run by national and local organisations that include LEPs, councils and universities. Typical funding rates are up to 30% of project’s costs.

An example of a Growth grant is the “Business Growth Programme 2” which is designed to strengthen supply chains, stimulate innovation and help SMEs grow in the Greater Birmingham & Solihull and The Marches LEPs, offering grant funding of up to £1 million.

Basis for Comparison Bank Loans Convertible Loans Government Loans
(incl. Innovation Loans)
Regional Growth Loans Regional Growth Grants Innovation Grants
Repayment Must be repaid during a specified term Must be repaid after maturity or converted into equity Comparatively more favourable terms/longer repayment duration Comparatively more favourable terms/longer repayment duration Not required Not required
Interest Varying rate, comparatively high Agreed set rate Comparatively lower rate Comparatively lower rate No interest applies No interest applies
Sources Many (Banks, Financial institutions, Hedge funds) Many (Financial Institutions, Hedge funds) Comparatively limited (UK government bodies) Comparatively Limited and Regional (UK government bodies, local councils, LEPs) Comparatively Limited and Regional (UK government bodies, local councils, LEPs) Comparatively limited (UK/EU government bodies, trusts)
Availability High High Competitive Competitive Competitive Highly competitive
Purpose Any commercial purpose Any commercial purpose Specified or authorized Specified and Regional Specified and Regional Specified


Which is right for you; Loan or Grant?

Grants are a great form of financial assistance as they are non-repayable. However, they are subject to stringent qualifications and usually limited in the amount of financing that they can provide. Access can also be very competitive.
Loans are very different. They are inherently risky as there are penalties for failing to repay them. Accessibility and amounts available depend only on a business’s creditworthiness and ability to repay.

If you are looking for finance, you should consider a number of factors before deciding whether a grant or a loan is available or suitable. These include:

  • Financing objective; Does your project or venture qualify for the more specific criteria or aims of the grants available in your region? If not, you will need to look for loans.
  • Timeframe; The typical grants process can take several months, without offering any guarantees. Additionally, grants may only be available at certain times of the year.  How urgent is the need for finance? If time is of the essence, a loan will be more suitable, especially as grants are often given as reimbursements.
  • Ability to repay; This is the key factor for choosing a loan. The terms and qualifications reflect your ability to repay the loan and the riskiness of your venture. You may simply not have the ability to access a loan.

Best of both worlds; Grants and Loans?

Each business has unique needs and priorities but usually grants and loans can be combined effectively to finance innovation and growth. They are not mutually exclusive and you should find out what grants AND loans are available to your business.
Accessing grants and government loans can be time-consuming and complicated. If you need an expert team to guide you through the process and maximise your chances for success, get in touch for a no-obligations consultation.

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The article was written by Yannis Efthymiopoulos.