In the not-so-distance past, it was almost always required that businesses put up some kind of collateral for a loan or line of credit. Offering up something of value guaranteed that, if the business should fail, the bank wouldn’t walk away from the relationship empty-handed. This type of loan, also called a “secured loan,” still exists, and collateral is required of many of the business-targeted funding products available today. But is it the only way for a company to obtain funding?
Types of Collateral
Some of the more traditional lending options, such as loans offered through the SBA (Small Business Administration), still ask that applicants secure their loans with something of value – usually their home or a mix of business and personal assets. This makes sense, as the SBA is a government-administered entity that exists because of tax-payer funding. While they don’t lend money themselves (but rather match lenders to appropriate and willing businesses), they have a keen interest in making sure the default rate is low. They want businesses to succeed, and they gain nothing by having a hand in failed lending schemes.
But not all loans will ask that you put your home on the loan. In fact, if the loan is very specific, and used to purchase assets that can later be resold, the asset purchase alone may be enough for collateral. Much like when you buy a car, the bank can simply repossess your financed purchase and try to collect the balance through traditional debt collection means. If you use your business loan to buy a new stove for your restaurant, for example, you can state the purpose of the loan on your application and put the stove up as collateral. Approval odds go up significantly when you can secure the debt with an asset directly-related to your business (vs. asking for unsecured funds.)
Another type of collateral is cash or other assets that can be liquidated quickly, such as business stocks, bonds, and CDs. These are seen as a stable form of collateral, in that they are as good as cash if something were to go wrong with the loan repayment. Money not yet earned is another category of assets that are similar to cash. Accounts receivables, usually given to the back as invoices yet to be paid, can stand in as collateral; these aren’t quite a stable, as they depend entirely on the business being able to collect on its own debts.
(Note: Invoice-based lending is sometimes marketed as “collateral-free or unsecured.” Your invoices are the collateral, however.)
When Is It Required?
Lending institutions set their own rules for collateral, and like any creditor, they can make decisions based on any of the following factors:
- Business history
- Business sales
- Business revenue and assets
- Credit history of business and business owners
The better you rank in any of these categories, the more likely you are to get a secured loan with collateral that’s close to the value of the loan you are requesting. Banks can and do ask that your collateral be worth more than the value of the loan in some cases to cover the costs of them liquidated your secured property if it comes to that. If you have a better credit history and business performance, it is more likely that you can borrow more than you secure (as in the case of using the loan to buy equipment or supplies.) It’s not uncommon to see 95% loan-to-value ratios.
When You Might Skip It
There’s good news for people who aren’t interested in putting their home up for security or aren’t interested in using lending funds to buy tangible items with resell value. For companies looking for a quick infusion of cash for a marketing campaign, upgraded technology, or other non-tangible costs, there are other types of loans that don’t ask for collateral. These take many forms, but the basics are:
P2P Loans – Working through a peer-to-peer lending service that caters to businesses is one option for a collateral-free loan. Rates and loan amounts vary, and you’ll have to prove you’re fit for the risk involved. Consider the application process similar to applying for a credit card or other non-specific loan.
Lines of Credit – A personal line of credit can be used for business purposes, although the limits for this type of funding are usually pretty low. Expect to go through an existing lender and pay rates higher than you would for a regular business loan. These can be used to get through a short-term slump or to make a small, but necessary business purchase.
Business Credit Cards – If nothing else, business purchases can be made with a business credit card, which is almost always unsecured. Credit rates are the highest for this option, and you’re not likely to get as much as a secured business loan. The perks to going this route, however, are the protections that many credit cards provide. The best business credit cards offer purchase protections for items bought with the card. (Check the terms of your card for details on what may be excluded.)
So, can you get a business loan without collateral? Some people can. Others — depending on their business history, personal credit score, business credit score, and loan amount – will have to start looking at the things they own to use as security for lending. Whether you will need it or not, it’s always a good idea to consider all of your assets and whether any of them are available or suitable for use as collateral. If you’re not in a position to part with anything, such as owning a home with two mortgages, you’ll probably find your lending options to be limited and smaller.
As the world of lending grows, however, look for the funding possibilities for businesses to expand, also. Between P2P lending, crowdfunding, angel investing, and the myriad of business cards on the market, there is likely a suitable option for even those business owners who can’t afford to risk any of their assets.
This article was originally written on November 19, 2018 and updated on December 10, 2020.