Collateral Requirements for Small Business Loans

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:

• Personal Credit Scores: Important When Seeking a Small Business Loan
• FICO SBSS: What’s Your Business Credit Score?

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.