The vast majority of small business owners will need to obtain a loan at some point in their company’s lifecycle, whether it’s to get the venture off the ground or to grow to scale once business is booming. Business loans require collateral, a concept which small business owners may not be familiar with, especially if it’s their first time as a borrower.
In this article, we’ll dive into everything that you need to know about business loan collateral, different types of business loans and the collateral associated with them, and the possibility of obtaining a business loan without collateral.
What is used as collateral for business loans?
Collateral for a business loan means a resource or asset that the bank or other financial institution will receive, should the borrower fail to pay back the loan. Real estate, equipment, inventory, or future receivables (payments from customers for services or products) are the most common forms of collateral offered by businesses in exchange for a loan.
Using your home as collateral for a business loan is a relatively common practice which is legal in most states. However, it does come with the major risk of you losing your residence, should your business run into financial difficulties.
Cash can be used as collateral for a business loan, along with other financial assets and securities such as stocks, corporate bonds, treasury bonds, stocks, and certificates of deposit (CDs.)
Essentially, lenders are looking for you to provide assets of financial value which they can take possession of or liquidate in case you are not able to pay back the loan.
How much collateral is needed for a business loan?
The collateral needed for a business loan depends on a number of factors, including the perceived risk of granting the loan from the lender’s side and the amount of funds requested by the borrower.
Business loan collateral requirements are typically dependent on the potential risk that the loan poses to the lender. Your collateral requirement will be determined based on the following factors:
- Your business credit score and credit history
- The likelihood that you’ll make punctual, reliable payments each month
- The amount of capital currently invested in your business and its profit margin
- The loan’s conditions, such as the amount of money requested, length of time of the loan, interest rate, and more.
Let’s say that you have an excellent business credit score, a solid history of responsible fiscal management, a profitable business, and request a relatively small loan of $30,000. While you will need to offer up collateral, the chances are that the value of said collateral won’t be significant.
Conversely, if you have a shaky financial history or low business credit score and request a large sum, the lender will require a substantial amount of collateral, likely equivalent to the amount of the loan itself.
As a general rule of thumb, banks are risk-averse institutions. Don’t be surprised that even with a good business credit score, a lender requires you to put up collateral that’s nearly or almost the same value as the amount of funding you request.
Collateral based on the type of business loan
Just as there are various types of business loans, there are numerous types of collateral that correlate with each loan.
A loan made via a lender approved by the Small Business Administration will require standard collateral. This typically encompasses assets such as personal real estate or business real estate, vehicles, equipment, accounts receivable, and inventory.
General small business loan
Similarly to an SBA loan, a standard small business loan offered by a bank will require collateral in the form of business assets or personal assets.
If you’re looking for a loan specifically for equipment for your business, like tools, machinery, or other physical assets, you may be able to secure a loan with the equipment itself as collateral. If you default on the loan, the lender will seize the equipment in order to recoup their losses.
This type of loan, also called inventory financing, sees a business obtain funds earmarked for purchasing products that the business will later sell. In this situation, the inventory in question acts as collateral, and can be claimed by the lender should the borrower stop repayments.
Accounts receivable and invoice financing
Invoice financing or factoring may serve as a form of collateral for a business loan. You promise the lender they can collect on future payments that you’ll receive from customers if you are unable to continue paying back the loan.
How to get a business loan without collateral
It’s next to impossible to get a business loan from a traditional financial institution or bank without offering substantial capital. But online and alternative lenders do offer you pathways to getting a business loan with no collateral required and provide other options for financing that aren’t loans.
However, it’s critical to note that no collateral upfront does not mean that you’ll be off the hook should your business fail or become unable to repay the loan. Every unsecured business loan that you take will require you to assume personal responsibility for repaying the debt.
Oftentimes, in exchange for a small business loan without collateral, you’ll need to agree to a personal guarantee or a Uniform Commercial Code (UCC) lien. UCC liens grant the lender permission to seize your personal property in the event that you stop paying your business loan. Online lenders may allow you to borrow without collateral in exchange for a UCC or personal guarantee.
The Small Business Administration (SBA) offers 7(a) loans, which allow businesses to borrow up to $25,000 without collateral. If you need a larger amount, up to $350,000, the SBA requires its lenders to collateralize to the maximum extent – and you can offer up personal assets, such as your home, as collateral in this situation.
The old adage “there’s no such thing as a free lunch” rings true here. While you may be able to secure a loan with no collateral upfront, you will need to pledge to surrender your personal or business assets should you default.
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