Collateral Requirements for Small Business Loans

The old adage, “It takes money to make money” is especially true for small business owners. To operate a healthy business, most need capital for business building initiatives. There are several ways to raise capital such as crowdfunding via a platform like GoFundMe, attracting angel investors, bootstrapping (launching a business with little or no cash investment or other support), or asking your friends and family to invest in your business. These options vary widely in success rates and risk.

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A small business loan is a good option to infuse your business with money, but finding the right loan can be a complex process. Business owners who want to grow their business have lots to think about before starting the application process. Borrowers want to get the most bang for their buck while economics of banking typically involve interest and other fees. One important detail to nail down is if a loan you’re applying for requires collateral. Lenders may require collateral to hedge the potential risk if borrowers can’t repay the loan. Below is a rundown about collateral requirements and alternatives.

What is collateral?

Collateral is something pledged as security for repayment of a loan to be forfeited by the borrower in the event of a default.  Any business asset that has value, and can be sold by the lender to pay off the loan,  may be considered collateral.

Assets that can be used for collateral for a small business loan

Below  are some examples of assets that lenders may request as collateral:

1. Real property

Real estate or home equity is one type of “real property” that can be used as collateral. Real estate is a desirable asset due to value retention. One thing to consider when  using your property or equity as collateral is that it  may cause a negative impact on your personal finances or net worth. If you default, and are unable to satisfy your debts, you may end up losing the real property.  Real property can also be classified as business equipment, vehicles, boats, motorcycles, etc. Speak with a financial advisor to assess the risk vs. benefits of this type of collateral.

2. Inventory

If you have a product-based business, you  may offer inventory as loan security. However, keep in mind that your inventory might not be as valuable to a lender as you think. To determine the worth of particular inventory, an auditor may be brought in to properly value your inventory.

3. Cash

Everyone loves cash! Especially lenders looking to ensure a loan. Using a savings account as collateral helps lenders avoid the time and effort of selling an asset. This type of strategy,  similar to real property, is considered high-risk so check with a professional and assess  all your options.

4. Invoices

One of the biggest cash flow challenges small business owners face is waiting for payment on outstanding invoices, however,  you might be able to  turn that into a positive by using those outstanding invoices as collateral. Using a strategy known as invoice financing, you’ll receive cash from your lender, and they’ll collect on the outstanding invoices.  However, you may still  be responsible for any fees or other costs. In this scenario, the amount you can borrow may  be limited, and the loan may  be capped below the total value of your invoices.

5. Liens

A lien is a legal filing that gives a lender the right to your property or assets if you fail to repay a loan. One type is a blanket lien, favored by lenders as it gives them the right to seize every asset and form of collateral a business owns to satisfy the loan amount.

Having a lien may  make qualifying for a new loan more challenging. Lenders want to be in the “first lien position   which means they get first dibs if asset liquidation is needed.

Securing a business loan without collateral

Unable to provide collateral for a business loan application? There are business loans out there that don’t require collateral, but approval may be more difficult than others. If you’re interested in applying for a loan without collateral, below are some   considerations to help you strengthen your financial profile:

Clean up your credit

When seeking business funding, it’s important to identify and fix any problems or discrepancies on your credit reports. The Fair Credit Reporting Act allows you to get  one free credit report every year  from each of the three major credit reporting bureaus - Equifax, Experian, and TransUnion. If you get reports from all three at separate times, you’ll be able to pull a free credit report once every four months to identify issues or problems that need to be dealt with in a timely manner.

In addition to checking for accuracy, strive for a high score. Lenders associate high credit scores with less risk, so you  have a better chance of getting favorable rates and terms if you have strong scores. Below  are some general  tips to follow to keep your scores in check:

  • Keep balances low on credit cards and other revolving credit
  • Pay off debt rather than moving it around
  • Don't close unused credit cards as a short-term strategy to raise your scores
  • Don't open unneeded new credit cards

Since good credit is such an important element when applying for a low-cost business loan, the  SmartBiz® Small Business Blog has covered this topic extensively. Read the following  detailed articles for more information on how to establish credit, how business and personal credit scores are calculated, how lenders view credit scores, and how to improve yours:

Create a solid business plan

Many lenders will review your business plan before agreeing to fund a loan. Therefore, your business plan should show lenders a good reason they want to offer you a low-cost loan.

Other reasons for creating a business plan include defining new business, outlining an agreement between partners, setting a value if selling your business, and to help you manage and track business planning. On top of all reasons to have a business plan in place, the process of writing your plan can be insightful. You’ll see where you’ve been and have a plan for where you’re headed.

If you don’t have a business plan, use our handy guide from the SmartBiz Loans® Resource Center to help you get started:  Ultimate Guide: How to Start a Business Plan.

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Research lenders

It’s helpful to research various lenders before starting the loan application process as they all differ in types of financing, qualifications needed, fees, credit requirements, and more. Your goal should be to find a lender offering the lowest cost funds with the  longest terms. Small business loans with long terms typically have very low monthly payments. Low monthly payments help you budget and keep a handle on your  business cash flow.

When researching, don’t forget to check out the customer service available. Is there an easy way to reach the lender via phone or online chat? Read online reviews from real customers to see what they say about the service and resources available to help.

Apply for an unsecured business loan

Your business may qualify for a business loan without collateral if you meet the following criteria. Check with your lender for specifics and be sure to pay attention to rates and terms:

  • Healthy cash flow and ability to make timely payments
  • Positive business projections
  • Financial records of consistent profits
  • Excellent credit scores

Best options for business loans without collateral

1. Small Business Administration loans (SBA loans)

SBA loans do not require collateral but a lien on business assets is required for an  SBA loan from a bank in the SmartBiz network. However, there is no minimum requirement for the value of those assets.

SBA loans are known as the “gold standard” in small business loans because of low rates, long terms, and very low monthly payments. Funds from an SBA loan can be used for many business building initiatives like equipment purchases, marketing, hiring, and inventory. You can also save big with  an SBA loan for debt refinance. SmartBiz Loans® has streamlined the  SBA loan application process and funds can be available as soon as 7 days after you complete the required paperwork. Start an SBA 7(a) loan application  here.

2. Merchant Cash Advances (MCAs)

An MCA provides a quick solution for those in need of short-term financial assistance and for business owners who’ve been denied a traditional loan from their local bank. They require very little paperwork, no collateral, and can be approved and funded within a day or two, even for business owners with a low credit rating.

Unfortunately, the convenience of cash advance loans comes with a catch—mostly in the form of exorbitant interest rates and hefty fees. If you’re considering applying for one, make sure you fully understand the downsides of merchant cash advances. Read this post from the SmartBiz Small Business Blog for additional information:  What Your Business Needs to Know About Merchant Cash Advances.

3. Business credit cards

Small business credit cards give business owners access to a revolving line of credit. They have a set credit limit and allow you to make purchases and withdraw cash. Like a consumer credit card, a small business credit card carries an interest charge if the balance is not repaid in full each billing cycle. You can get approved for a credit card through a bank or you can compare card terms and features and apply online. Read  Six Benefits of Using a Business Credit Card for more information.

The bottom line on collateral

Aim to avoid putting your business or personal assets at risk, by only signing on the dotted line for a loan that you believe you can repay. It’s important to work with a financial professional and crunch the numbers, keeping previous years and the current economic climate in mind. Strive to work with a lender who has excellent customer service if issues or questions come up.

WHAT YOU NEED TO KNOW: The SmartBiz ® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.

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