Loan agreements 101: A simple guide to unsecured business loan agreements for SMEs

A loan agreement sets out the terms of a loan - how much is being borrowed, how it will be repaid, and what happens if repayments aren’t made on time. Without a clear, legally binding contract, disputes can arise, leaving both lenders and borrowers exposed to financial risk.

Whether you're lending funds to help a business get off the ground or borrowing money to support growth, a loan agreement provides legal certainty and helps prevent misunderstandings. This guide covers everything SME owners need to know—from what a loan agreement is and why it matters to the key clauses to include when drafting one.

What is a loan agreement?

A loan agreement is a legally binding agreement that sets out the terms on which one party (the lender) agrees to provide a loan to another party (the borrower). It details the amount being loaned, repayment terms, interest (if applicable), and any conditions that must be met.

For business owners, loan agreements are crucial when:

• A company borrows money from an individual (such as a director or investor) or another business.

• A business lends money to another company.

• Clear repayment terms and legal protections are needed.

How is a business loan agreement different from other types of loans?

• Business loan agreement vs. personal loan agreement: A business loan agreement is strictly for commercial purposes, whereas personal loan agreements often fall under consumer credit regulations.

• Business loan agreement vs. bank loan agreement: A standard business loan agreement typically offers more flexibility than a bank-issued loan, which may include stricter financial covenants.

• Unsecured vs. secured business loan agreements: Some agreements require collateral (secured loans), while others do not (unsecured loans).

A well-drafted loan agreement ensures transparency and reduces the risk of disputes, providing both lenders and borrowers with peace of mind.

Why do businesses need a loan agreement?

A loan agreement is essential for any business borrowing or lending money. It provides a clear, legally binding framework that protects both parties and ensures the loan terms are properly documented. Here’s why its important that a business uses some form of loan agreement where they will be borrowing/lending money:

1. Legal protection

Without a written agreement, misunderstandings about repayment terms, interest rates, or loan conditions can lead to disputes. A properly drafted loan agreement clearly sets out each party’s rights and obligations, reducing the risk of legal issues.

2. Clarity on repayment terms

A loan agreement outlines:

• The total amount borrowed.

• Whether the loan is interest-free or interest-bearing.

• How and when repayments must be made (e.g., lump sum or instalments).

• What happens if the borrower fails to repay on time.

This clarity helps businesses manage cash flow and plan for repayments effectively.

3. Proof of the loan for accounting & tax purposes

A loan agreementserves as evidence of the transaction, which is useful for:

• Keeping accurate financial records.

• Avoiding tax complications by demonstrating that the funds are a loan, not income.

• Showing compliance if the business is audited.

4. Enforcing repayment in case of default

If a borrower fails to repay, a written agreement gives the lender legal grounds to take action. The agreement can include default clauses, allowing the lender to demand immediate repayment if certain conditions are breached (e.g., missed payments, insolvency).

5. Ensuring compliance with financial regulations

Business loans must comply with relevant laws, such as consumer credit regulations (if lending to individuals) or financial reporting obligations. A well-drafted loan agreement helps ensure the transaction is legally sound.

6. Building trust between the lender and borrower

A formal agreement reassures both parties that the loan is structured fairly and professionally. This is particularly important when loans are made between business partners, directors, or investors, helping to maintain strong business relationships.

By using a legally compliant loan agreement template, businesses can simplify the process while ensuring their interests are protected.

Key clauses to include in an unsecured loan agreement

A well-drafted loan agreement should include key clauses that outline the terms of the loan and protect both the lender and borrower. Here are the essential provisions to consider:

1. Loan amount and repayment schedule

This clause defines the total amount being loaned and outlines how the loan will be repaid. Repayment can be structured as a single payment, where the full amount is provided upfront, or in instalments, where the loan is disbursed in stages over time. The chosen structure can significantly impact repayment planning and cash flow management for both parties, so it's important to ensure that this clause is clear and unambiguous.

2. Repayment schedule

Clearly setting out repayment terms helps avoid disputes. The agreement should specify:

• Payment frequency: Monthly, quarterly, or in a lump sum.

• Repayment structure: Equal instalments or variable payments.

• Prepayment options: Whether the borrower can repay early without penalties.

Having a defined repayment plan helps businesses manage their cash flow efficiently.

3. Interest terms

The agreement should specify whether the loan is:

• Interest-free: no interest is charged, often seen in loans between related businesses.

• Interest-bearing: a fixed or variable interest rate applies.

If interest is charged, the agreement should also include:

• The interest rate (e.g., fixed percentage or linked to an external benchmark like LIBOR or the Bank of England base rate).

• Whether interest compounds or is simple.

• Any penalties for late payment of interest.

4. Representations and warranties

This clause sets out assurances given by the borrower to the lender, ensuring that the borrower has the legal capacity and authority to enter into the agreement. It typically includes confirmations that:

• The borrower has all necessary power and authority to execute, deliver, and perform their obligations under the loan agreement.

• The agreement does not breach any laws, regulations, or existing contractual obligations.

• No existing event of default is ongoing, nor would one arise from the lender providing the loan (see the below section for more information on "events of default").

Including clear representations and warranties helps lenders mitigate risk by ensuring that the borrower is in a legal and financial position to take on the loan. If any of these warranties prove to be false, the lender may have grounds to terminate the agreement or demand early repayment.

5. Events of default

This clause defines situations where the lender can demand immediate repayment. Common default triggers include:

• Missed loan repayments.

• The borrower becoming insolvent.

• A significant breach of contract terms.

Setting clear default conditions helps lenders manage risk and enforce repayment if necessary.

6. Governing law and jurisdiction

To ensure legal enforceability, the agreement should state:

• Which country’s laws apply (e.g., English and Welsh law).

• Which courts will handle disputes (e.g., the courts of England and Wales).

This clause prevents uncertainty in case of legal action and ensures both parties know where disputes will be resolved.

By including these key clauses, businesses can create a legally sound loan agreement that protects their financial interests while maintaining transparency and trust between the lender and borrower.

For more guidance on the key clauses to include in a comprehensive unsecured loan agreement, read this checklist.

Tips for crafting a robust unsecured loan agreement

Drafting a business loan agreement is an important step in ensuring both the lender and borrower understand their rights and obligations. A well-crafted agreement reduces the risk of misunderstandings and legal issues down the line. Here’s a step-by-step guide to drafting a business loan agreement:

1. Define the loan amount and purpose

Start by clearly stating:

• The total loan amount being provided.

• The purpose of the loan, whether it’s for working capital, equipment purchases, or another specific business need. This helps both parties understand the scope of the loan and ensures it’s used for the intended purpose.

2. Determine the loan terms

Next, specify the terms of the loan, including:

• Interest rate: Will the loan be interest-free, or will interest be charged? If interest is applicable, outline the rate and whether it is fixed or variable.

• Repayment schedule: Define how and when the loan will be repaid. This could be in monthly, quarterly instalments or a single lump-sum repayment.

You should also include any penalties for late payment to encourage timely repayments.

3. Security and collateral

If the loan is secured, clearly identify:

• The collateral being offered (e.g., property, inventory, accounts receivable).

• The consequences of default, including how the lender can seize the collateral if the borrower fails to repay.

If the loan is unsecured, you may want to consider including personal guarantees from directors or other responsible parties to further protect the lender.

4. Outline events of default

List the circumstances under which the borrower will be considered in default. Common events include:

• Failure to make a payment on time.

• Insolvency or bankruptcy of the borrower.

• A significant breach of the loan terms.

This clause gives the lender the right to demand immediate repayment or take legal action if necessary.

5. Include legal terms

Make sure to include standard legal clauses to ensure the agreement is enforceable:

• Governing law and jurisdiction: Specify which jurisdiction’s laws apply (e.g., English law) and where any legal disputes will be handled (e.g., in UK courts).

• Amendments: Outline how the agreement can be modified or amended if necessary.

• Notices: Specify how official communication should be sent (e.g., by post, email).

6. Finalise and sign the agreement

Once both parties agree on the terms, the agreement should be signed by the lender and borrower. With Docue’s built-in e-signature function, you can securely sign and store your loan agreement online, ensuring a fast, hassle-free process without the need for printing or scanning.

By following these steps and using a well-structured loan agreement template, businesses can ensure the terms of the loan are clear and legally binding, protecting their interests and avoiding future complications.

Why choose Docue to create your loan agreement?

At Docue, we understand that creating a loan agreement from scratch can feel overwhelming. That’s why our loan agreement template simplifies the process by including all the key provisions necessary for a legally robust and enforceable contract. 

Professional: Our templates are drafted and maintained by qualified lawyers, so you can be confident that you have a professional-quality loan contract template at your fingertips, without the stress of drafting it from scratch.

Simple: Our loan agreement template is easy to use and intuitive. Once you’ve answered all of the questions, you’ll have a simple loan contract that’s fully tailored to your needs.

All-in-one solution: When it’s finalised, you can send it for signature via Docue’s e-sign function, and store all of your documents in Docue Drive.

Ready to get started? Sign up with Docue today.