A new survey conducted by the Federal Reserve shows 71% of employer firms plan to increase revenue over the next 12 months, and 46% plan to hire. American businesses are looking to expand.
Growing operations often means seeking capital to support it. But getting the right capital is no easy feat, especially if you’re trying to minimize costs with low-interest financing. If you’ll be in the market for financing this year, you’ll need to know about a common requirement from lenders that can affect your chances at securing the best financing for your business: collateral.
Collateral is required by some lenders as a “just in case” plan for them to recoup a loss should you default on your loan. It can be any asset that a bank or lender deems they can sell for cash. Lenders are looking for assets that require them to put in as little effort as possible to liquidate so that if you do default, they don’t have to spend additional money recovering the cash they lost from lending to you.
Quick note before we continue: using an asset you aren’t comfortable parting with as collateral can be risky business. Your home is an example of something that could cause serious heartache should your business fail to pay back a loan, but maybe for you there’s a different item. Whenever co-mingling your personal and business finances, there can be risk involved. With that in mind, read on for items to consider using as collateral on a business loan.
Equipment is a common collateral option accepted by many lenders. They’ll appraise the value of your equipment, and often that value will be significantly less than the equipment’s market value. Let’s brainstorm a few equipment ideas:
- If your business operates out of an office: Espresso machines, computer equipment (laptops, monitors) and office furniture (chairs, desks, couches, tables).
- If you run a retail shop: Display furniture, security system equipment, casings or high-value artwork you’ve displayed.
- If you run a contracting business: Tools such as jack hammers, miter saws, compressors, table saws and bigger ticket items such as trucks you use for work purposes.
- If you run a farm: You’ll have plenty of big-ticket items such as tractors, mowers, cultivators and irrigation engines and you should talk to your lender about which ones may work for you.
2. Property & Home Assets
Real estate assets are another common form of collateral for a small business loan. This can include equity from both your home or any buildings your business owns.
If you’re a renter, this makes things a little harder, but you can still use assets in your rental space. Depending on the lender, you may want to discuss using items such as jewelry, art, furniture or personal equipment such as landscaping tools.
Doug Sands of Restaurant Clients Magnet recalls the trials of being a renter in need of collateral, but was able to use personal home items as collateral for the loan: “I scavenged funds from my Roth IRA, and then had to list my bed, my TV, my computer and my fridge (these were days when I was renting, and they were literally my most valuable assets) for a small business loan.”
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3. Accounts Receivable
Many businesses don’t require their customers to pay upfront for products and services. If you fall into this category, you have account receivables that indicate you have accrued revenue.
Lenders will value your receivables based on their amount and whether or not they are overdue. According to Ronald Blok, former CEO of RaboBank N.A., banks will always exclude receivables older than 90 days and receivables to related parties such as the owner. A typical valuation you might expect banks to assign to your eligible receivables can be somewhere around 60% or 70%.
4. Your Inventory
If you operate in an industry where your inventory won’t rapidly expire, you may be able to use it as collateral. This would apply to companies like clothing retailers, toy manufacturers and hardware companies.
With respect to inventory, lenders are conservative. If the market value of your inventory is $100, for example, the lender would likely place a $50-$60 valuation on your inventory.
5. Investments & Intangibles
Personal investments such as stocks, bonds and certificates of deposit can be used as collateral for a business loan. Because the value fluctuates over time, the bank may discount the current value of personal notes.
Bryan Clayton, CEO of GreenPal, recalls that his business partner was able to use royalties from a previous venture: “My co-founder before starting this business was a songwriter … he was able to help us secure a $50,000 line of credit by pledging some of his song royalties as collateral.”
No Collateral? Here Are Some Alternatives
Many lenders, including online lenders, will only require a general lien on your business assets, as well as a personal guarantee to secure the loan, instead of placing a lien on specific collateral. This does not require valuing those assets, but it does mean that anything your business owns is up for grabs should you default.
A word of caution: there’s a common tradeoff for the convenience of cutting the collateral requirement, and that is cost. Business financing options that only require a personal guarantee or a general lien on your assets may come with a bigger price tag in the form of higher interest rates than loans that require collateral. Make sure you know the full cost of the loan before you sign on the dotted line. Your business credit scores will also play a major factor in the interest rate you’ll be facing for most business financing options, so it’s important to know where you stand. You can check your business credit data for free at Nav.
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