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When you research how to get a business loan, you’re sure to come across a common term—collateral. Collateral is a frequent business loan requirement, but it’s not necessary with every type of business financing.
Some lenders want you to supply collateral when you take out a new business loan. Others won’t require collateral when your business borrows money. Finally, certain lenders may allow you to decide whether or not to put up collateral when you borrow, and the cost of your loan could vary according to your decision.
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What Is Collateral?
Collateral is a term that describes an asset you pledge to a lender when you take out a loan. Should your business borrow money and fail to repay the debt as promised, collateral provides the lender with another way to recover its investment by seizing the asset. Collateral, at its core, is a security measure.
When you pledge collateral to a lender, your loan is secured. Financing that you take out without any collateral backing is unsecured. So, if you’re researching funding options for your business and you come across the term “secured,” you know that some sort of deposit or collateral is required by the lender. Unsecured financing indicates the opposite.
Common Types of Collateral for Business Loans
Lenders may accept a variety of different assets as collateral, depending on your business loan type and other factors. Examples of acceptable collateral for business loans may include:
- Real estate
- Business equipment
- Accounts receivable
- Investments (i.e., stocks, bonds, etc.)
- Personal assets
In some cases, the property you are borrowing money to purchase—such as an office building, business vehicle or equipment—may double as collateral for the loan. Let’s say, for example, that you borrow money to purchase a truck for your business. However, your business falls behind on its payments. In this scenario, the lender can repossess the vehicle (seize the collateral) and resell it to a third party.
How Much Collateral Do Business Lenders Require?
The amount of collateral you must provide a lender for a secured business loan is based on many factors. Your credit (business and personal), capacity to repay, availability of capital and loan conditions—all part of the five C’s of credit—could influence a lender’s collateral requirements.
If you do need to provide collateral to secure funding, there’s a general rule that most lenders follow. Any assets you pledge should be worth at least as much as the amount your business wants to borrow.
In other words, if you want to take out a $100,000 secured business loan, you may need to provide $100,000 worth of collateral to back the financing. Pledging assets to the lender that match or surpass the amount of funding your business needs reduces the lender’s risk and can make you a more attractive borrower.
The Value of Collateral
There’s another key factor at play that you should understand where collateral is concerned. Your definition of value might not match up with a lender’s definition. The value of collateral is subjective.
Imagine you have a piece of property that appraises for $100,000, and you want to pledge it as collateral to secure a business loan. The lender likely won’t give you credit for the full appraised value of the asset. Instead, the lender may consider that property to be worth just 80% to 90% of its appraised value, just in case the lender cannot resell the property for the full value for any reason.
This discounting of value can have an impact on the amount of money your business can borrow. If a lender only accepts 80% of your property’s value in the scenario above, you would only have $80,000 worth of collateral. In this situation, you’d likely need to take one of the following actions:
- Supply additional collateral that the lender will accept
- Provide a larger down payment
- Borrow less money
Collateral by Type of Business Loan
The type of business financing you want will also play a role in the collateral requirements you face. It’s important to check with any lender you’re considering doing business with to learn its specific loan requirements.
Below are a few examples of the collateral you might expect to provide for different types of business funding.
- Equipment financing: When you finance equipment for your business—manufacturing, construction or otherwise—the asset you’re financing typically serves as collateral for the loan.
- Online business loan: If you borrow money from an online lender, you may not need to supply traditional collateral. Instead, an online lender might require a personal guarantee or perhaps a blanket lien to protect its investment. A blanket lien gives a lender the right to repossess all collateral that your business owns if necessary.
- Invoice factoring: With invoice factoring, your unpaid invoices serve as a form of collateral for your business loan. In practice, your business sells its outstanding invoices to a factoring company and receives an advance—typically 80% to 95% of the invoice value. The factoring company then collects the unpaid invoices and you pay a factor fee (usually around 0.50% to 5% per month) until your customers pay off their outstanding balances.
Can You Get a Business Loan Without Collateral?
It is possible to qualify for a business loan without supplying collateral to back your financing. But, if you’re seeking an unsecured business loan that doesn’t require collateral, the lender is taking a bigger risk. As a result, there may be some tradeoffs, including:
- Your choice of lenders could be more limited. If you want to take out an unsecured business loan, some lenders might not be willing to work with you. Certain U.S. Small Business Administration (SBA) loans, for example, may have nonnegotiable collateral requirements. Online lenders, by comparison, may be a better resource for unsecured business loans. But you still might have to sign a personal guarantee to cover the lender in the event of a default.
- You might need better credit to qualify. Business lenders often consider both your business and personal credit score when you apply for a business loan. If you want an unsecured business loan, especially from a traditional lender, the minimum credit criteria may be stricter than it would be if you were pledging assets.
- Interest rates and other loan terms may be less attractive. Unsecured loans are riskier for the lender. As a result, the lender may charge you more, loan you less money or ask for a bigger down payment to help offset the added risk exposure.
Note that even if you qualify for unsecured business funding, you may need to agree to provide a personal guarantee. With a personal guarantee, a lender or credit card issuer may have the right to file a lawsuit and come after your personal assets should your business default on its debt.
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Frequently Asked Questions (FAQs)
Is a personal guarantee the same as collateral?
Both personal guarantees and collateral serve the purpose of helping to protect the lender’s investment in the event of a default. But they deliver this protection in different ways.
With a personal guarantee, the lender has the right to hold you personally liable for the debt that your business incurred. Collateral, by comparison, gives the lender the right to take possession of the specific assets you pledged to back the loan.
If you put up equipment or inventory as collateral, for instance, the lender could seize those assets and attempt to resell them. This repossession process can help the lender recover some or all of the remaining unpaid balance on your debt.
How much collateral do you need for an SBA loan?
The SBA offers several different loan programs to eligible small business borrowers. The collateral requirements on an SBA loan will vary from one loan type to the next.
For SBA loans under $25,000, the SBA does not require lenders to secure collateral. But personal guarantees are still a must from anyone who owns at least 20% of a company.
On the other end of the spectrum, SBA loans over $350,000 require full collateralization—equal to the full loan amount your business is borrowing. And with other SBA loans, like the SBA 504 loan program, the asset your business is financing serves as collateral for the loan.
Does collateral improve my approval odds?
The ability to provide collateral can improve your business loan approval odds with certain lenders. Having assets to pledge to a lender can also open up more doors for your business—giving you more opportunities to borrow money from a wider variety of lenders.
With bad credit business loans, supplying collateral can be especially helpful. Remember, lenders only approve loan applications when they feel the overall risk level is acceptable. Bad credit increases the risk that a lender won’t get repaid, but acceptable collateral may help shift a loan’s level of risk back in a positive direction.