If you’re in the market for a small business loan, then your lender may (or may not) require that you put down collateral to secure the loan and minimize its risk. But with numerous types of collateral out there, understanding which option will work best for you can be confusing. After all, each comes with various perks and drawbacks, which can ultimately affect your business and personal finances in numerous ways.
Loans that require collateral are called secured loans. But while collateral can sometimes be necessary or help you unlock a better deal, it’s by no means required. You can also qualify for unsecured loans, which do not require collateral and are approved based on your credit score and financial reporting.
If you’re considering taking out a secured loan, it’s important to be aware of how different types of collateral could affect you. This guide will go over the most common types of collateral and how they affect your small business.
What Is Collateral, and Do You Need it for a Business Loan?
Collateral is an asset that, as the business owner, you put up when receiving a loan (or another type of financing) to lower the lender’s risk. In case you are unable to pay back your debt, the lender will seize your collateral in order to recover their losses. Collateral can take the form of real estate, equipment, inventory, and other options listed below.
Not all lenders will require collateral for a loan. Whether you will have to put up your assets in exchange for financing depends on a number of factors, including your credit history, financials, and the reason you need funds. Because SBA loans are backed by the Small Business Administration, though, most of these programs will require collateral.
In some cases, lenders will allow or require business owners put up their personal assets as collateral.
What Are the Benefits of Using Collateral for a Business Loan?
Although risky, offering collateral can yield many benefits for borrowers. Here are a few of the most prominent:
- Better rates and terms
- Higher funding amounts
- Reduced credit score requirements
- Longer repayment schedules
Offering collateral gives lenders an extra layer of protection against a defaulted borrower. It lowers their risk, which translates into more favorable terms for the borrower.
Types of Collateral to Secure a Loan
Different types of lenders will also have different collateral requirements. Depending on the kind of collateral you agree to put up, you’ll see various benefits and drawbacks. However, this can vary based on your unique situation.
|Type of Collateral||Description|
|Real Estate Collateral||Many business owners use real estate to secure a loan. This practice is common among mortgages, personal loans, and business loans as well.
Lenders view real estate favorably because it retains value well over time. Real estate is also typically worth several hundred thousand dollars, which gives you, the borrower, an opportunity to secure more funding.
While using real estate as collateral has its perks, it also comes with significant risk. For instance, if you use your primary residence as collateral and default on your loan, you could wind up losing your home.
|Business Equipment Collateral||Business equipment can be a viable and relatively low-risk type of collateral, especially if you run a construction or manufacturing business. Using business equipment is also generally safer financially than putting up your family’s home or another type of property.
The downside is that business equipment tends to lose its value over time. If you only own machinery that’s undergone wear and tear, it’s unlikely you’ll be able to use it to secure a large amount of funds.
Some lenders may also be wary of accepting certain business equipment as collateral, especially if it could be difficult to find an interested buyer.
|Inventory Collateral||Product-based businesses, such as retail stores or eCommerce shops, may be able to use their inventory to secure financing. However, there are some lenders who may be unwilling to accept inventory as collateral because it can be difficult to sell.
Using inventory can also have negative consequences on your revenue. In case you default on payments, you could lose access to inventory and, as a result, risk the ability to generate profit. This could potentially put you in trouble with other creditors or even bankrupt your business.
|Invoices Collateral||Many businesses, especially construction companies, have to contend with outstanding invoices and late payments. This creates cash flow issues that can leave you in need of additional funding.
Some lenders will approve you for financing in exchange for claim to your business’s outstanding invoices. This can be a great way to get much-need cash quickly without having to wait for your customers to pay you.
The downside is that lenders will still charge you fees or interest. In the end, this means that you’ll end up earning less money than if your clients were to pay you directly.
|Blanket Lien Collateral||Unlike other types of collateral, blanket liens give lenders the legal right to seize any and all of your business’ assets in the event you are unable to repay the loan.
Blanket liens offer significant protection for lenders while posing serious risks for borrowers. It’s possible to lose everything you own if you can’t meet your debt obligations. In most cases, this arrangement would only be used by banks and not FinTech lenders – like National Business Capital.
|Cash Collateral||If you have extra cash in your business bank account or even your personal bank account, you should be able to use it to back a secured loan. Cash is a relatively straightforward form of collateral and also a favorite among traditional lenders like banks. Fintech lenders generally don’t utilize cash as collateral.
If a borrower fails to repay their debts, lenders can get their money back immediately without having to sell a physical asset. This can translate into lower interest rates and fees for borrowers.
|Investments Collateral||Investments, like stocks and bonds, can be used as collateral for both business loans or lines of credit. Like cash, investments are liquid assets that can be sold off quickly to repay lenders. This is a common type of collateral at banks but isn’t popular with FinTech lenders.
However, investment valuations can fluctuate depending on market conditions. You could find yourself in a problematic situation if the value of your investments declines below the amount you borrowed.
What Factors Do Lenders Consider to Evaluate Collateral?
The collateral evaluation process takes many different factors into account. They’re different for each type of collateral, too, but the main goal is to determine the most accurate value of the collateralized asset.
Here’s a breakdown of what lenders consider for each type of collateral:
- Real Estate – Lenders use the “fair market value” of your real estate. This is determined by comparing the value of your home against the market value of similar homes and those in the surrounding area.
- Business Equipment – Depreciation is applied against the asset’s value to determine the true value at the time of the transaction.
- Inventory Collateral – The quality and quantity of your inventory is used to determine the collateral value.
- Invoices Collateral – Lenders will take the balance of your accounts receivable and use that as the value of your collateral.
- Blanket Lien Collateral – Since it’s a blanket lien, lenders will need to evaluate all your business assets to determine a total value.
- Cash Collateral – The dollar amount of your business’s cash equates to the collateral value.
- Investments Collateral – A lender will research the recent sale prices of your investments and may leverage a qualified expert for a second opinion.
Which Type of Collateral Works Best for You?
There’s no “one-size-fits-all” answer to this question. Only you, as the business owner, can decide which types of collateral for loans is best for your business. A good place to start is by looking into the assets that are available to you.
Do you have real estate, outstanding invoices, or investment accounts with significant value? Consider the assets you have available, and weigh the pros and cons of how putting them up as collateral could affect your finances in the event you can’t make payments. Additionally, be sure to understand what the lender is looking for as far as collateral value goes.
Finally, you want to assess whether using a certain type of collateral is worth the risk. It’s not a good idea to fund a risky venture by putting up your family’s home. Instead, try to a risk level you are comfortable with and confident in.
Should You Offer Collateral to Get a Business Loan?
Wondering whether you should be offering collateral in order to secure a loan? The answer depends on your business’s unique circumstances.
Some business owners may not have enough assets of value to put up for collateral. Others may be uncomfortable with the amount of risk secured loans entail. As a result, many businesses may opt for unsecured loans – which don’t require collateral and are based on other factors, such as credit history.
Collateral financing is a way for business owners who have trouble getting approved for unsecured loans due to their credit score or other factors. However, you can often qualify for unsecured products.
Collateral can help these kinds of business owners secure funding and even qualify for better interest rates, terms, and amounts.
Choose National Business Capital to Get Collateral-Secured & Unsecured Loan Options
Whether you’re considering taking out a secured loan or an unsecured loan, National Business Capital can help. We provide businesses with all kinds of financing options and guide them through selecting the best choice.
After applying, a knowledgeable advisor can help you understand your options with or without collateral. We can help you decide whether secured or unsecured financing is a better fit for your business based on risk and the terms you qualify for. You’ll have the opportunity to ask questions and understand your options before moving forward.
You can qualify for and receive financing in as little as a few hours. Get started by applying now!
Frequently Asked Questions
Why is collateral required for a business loan?
Collateral isn’t always required. If it is, it’s because the lender wants to minimize the risk of a financial loss.
Collateralized assets provide lenders with an avenue of recouping funds lost to a borrower’s default. Instead of losing the unpaid amount, they sell the collateral and come as close to breaking even as possible.
On the business side, offering collateral reduces the risk your company poses to the lender. This yields better rates, higher funding amounts, and extended repayment periods compared to unsecured loans.
Are there any restrictions on the types of collateral I can use for a business loan?
Yes, but it depends on the lender you’re working with. Banks are notoriously rigid in their collateral requirements, whereas non-bank lenders accept a wider range of assets.
The most widely accepted assets are described in the blog above!
Is there a minimum value requirement for collateral when applying for a business loan?
This depends on the loan amount. For example, you likely won’t be able to secure a $1+ million business loan with $30k in inventory, although you can combine multiple types of collateral to increase the total value.
Can I use my business as collateral for a loan?
Blanket liens collateralize all your business assets, which is essentially the same thing. If you default, you lose all the collateralized assets and – in most cases – your ability to do business.