Collateral for Business Loans – The What, Who and Why
One of the biggest sources of confusion in the commercial funding marketplace has to do with collateral for business loans: what it is, who determines valuation, and why it’s necessary — or in some cases, why it isn’t. To help you safely navigate the landscape of business loan collateral, here are the basics:
What is Collateral for Business Loans?
Collateral is anything of value that is used to secure a business loan in the event of a material breach or default. In such cases, the lender (governed by a process defined by the loan agreement) takes possession of some or all pledged assets, and liquidates them to cover the debt — which would include the principal, accrued interest, and any additional fees and/or penalties.
Collateral for business loans is not necessarily limited to physical assets, such as buildings, equipment, inventory, vehicles, and so on. It can also include intangible assets such as securities, mortgages, accounts receivables, and so on. Some lenders will also allow borrowers to pledge personal assets if they do not have sufficient business assets.
How is Collateral for Business Loans Valued?
Evaluating collateral for business loans is where many would-be borrowers experience an unwelcome surprise: lenders determine how much collateral is worth. What’s wrong with this? Well, it’s that some lenders — and banks are notorious for this — deliberately value assets at well below their market value. Is this illegal? No. Is it unethical? Arguably. Is there a reason for this? Definitely.
The reasons banks under-value collateral, is because it further reduces their risk exposure. Frankly, banks don’t want to take possession of a borrower’s assets. They aren’t in that line of business. However, if it’s necessary, then banks want to make 100% sure (make that 200% sure) that they come out ahead.
True, it’ll take them longer to generate profit, since they’ll need to take ownership of assets and then liquidate. But for most banks, waiting a few extra few months or even a year isn’t going to result in too much pain and suffering. And frankly, bigger banks won’t even notice.
What’s more, most lenders require that borrowers pay for the valuation process up-front. In other words, the fee cannot be integrated into the loan and financed. While the cost is not prohibitive, it’s not negligible either.
Is Collateral for Business Loans a Mandatory Legal Requirement?
The answer to this — despite what some lenders want borrowers to believe — is NO.
Many reputable lenders — including National Business Capital — offer several funding solutions that don’t require any collateral at all, including:
- Small Business Loans, which are short or long-term funding that is paid back through affordable fixed monthly payments.
- Business Lines of Credit, which allows borrowers to withdraw cash on an as-needed basis, and only pay interest on the amount drawn.
- Merchant Cash Advances, which are suitable for borrowers who conduct most transactions via credit or debit card (e.g. restaurants, auto repair shops, retailers, etc.), and which are paid back daily as a small percentage of sales.
In addition, since the above don’t require collateral, there is (obviously) no valuation process — which means the approval time is rapid. For example, it takes us one business day to review and approve an application for any of the above funding solutions, while it takes banks several months to assess and process a loan application.
If you’ve tried to apply for a bank loan without the required collateral, chances are that your bank turned down your application. To learn why banks reject loan applications and how you can get the funding you need, download our FREE eBook “How to Get Business Funding When Banks Say ‘No’” today: