Whatever industry you may be in, as a small business in the early stages, you will inevitably need access to money in order to expand, develop and complete much-needed products. Today, fortunately, you have access to a variety of small business loan sources. If opting to pursue a traditional bank loan, keep in mind that they are more than likely going to require collateral in order to qualify your company for funding. And while this may be a formidable hurdle for some businesses, we thought we'd put together a brief guide as to what you should expect and know when it comes to the collateral requirement.
In understanding why a lender asks for collateral, you need to grasp the fact that they see each company to whom they extend a loan as a potential risk first and foremost. In order to try and alleviate this risk somewhat, they ask for collateral to back the loan. So let's say for some reason you happen to default, they then have this collateral as security against nonpayment.
Therefore even if you have great credit, a stellar history of payments, and impressive cash flow, odds are they will still require collateral to approve your application.
What Can Be Considered Collateral?
The question of what exactly constitutes collateral is varied. Generally, banks like to see something that can be liquidated rather quickly—thus giving them back their money. To this end, of course, cash is the preferred form of collateral that they prefer to see pledged. Another highly accepted form are securities. This is because they can be bought and sold a lot easier than for instance real estate or equipment. So things such as stocks, treasury debt, bonds, CDs or even accounts receivable are all readily welcomed types of collateral.
Property (and real estate/) is yet another form. And while it is difficult to get the cash out quickly at times, the banks will still welcome this type of collateral as backing for your business loan.
Some Assets That Can Be Used for Collateral
While you can think outside of the box at times when coming up with things to utilize as collateral, generally speaking, there are five primary types of assets that banks like to see for you to get your loan. Having at least one of these can greatly improve your chances.
Cash
Certainly, this is going to be your best bet. And yes, it seems a bit ironic, if you have cash then why would you need cash—but this is actually a pretty common form of collateral in terms of business loans.
For instance, it can be a cash savings account, in this way the creditor can easily liquidate should the applicant default and thus the bank retains their investment. A cash secured business loan offers probably the least amount of risk for a lender.
Just keep in mind, that if you cannot repay the loan, the bank will take your life's savings by virtue of the account that you pledged as collateral. This, in turn, could jeopardize any future retirement plans.
Inventory
This is another popular form of collateral that many companies use to secure their business loan. The value of the inventory has to be there of course—which may mean an appraiser coming out to assign such value. Some inventory, depending on the nature of the industry, tends to depreciate over time.
Because of the volatile nature of inventory value, some lenders may be hesitant to engage in a loan with your company. There are though, lenders out there who do specialize in inventory financing. How it works is that entrepreneurs get a loan for the inventory that will eventually be sold.
Invoices
This may not be one of the more prominent forms of collateral—especially among those types accepted by banks, but invoice financing is fast becoming a great way for smaller businesses to get the cash they need. Basically, the lender will use your outstanding invoices against the loan. If all other requirements aren't necessarily where they need to be when you go to apply for your loan, invoice financing could be one of your more plausible options. And there are quite a few alternative and online lenders now open to working with smaller companies in this capacity. It could get you capital fast and you're not having to put up personal assets to secure the loan in question.
Property
With a property as collateral, the most common forms are home equity and of course real property. The value here is a bit trickier to determine then say with cash as collateral or invoices. But banks are usually willing to accept your property as security on the loan.
If though, you do put up personal property, just understand going in that if you default, they could essentially take your home. And if you are using the equity in your home, the same fate could befall you. Additional property that may be used: vehicles and other such equipment.
Blanket Liens
This may seem like an intimidating term, and that's because it pretty much is. Basically, a blanket lien means that if you default, the lender has the right to collect their money and thus reclaim their assets. Most banks will not agree to this unless they are in a first lien position. So if you already have creditors in place, this might not be a viable solution for you.
Remember, with a blanket lien only the lender is protected. You as the borrower are afforded no such protections and thereby could stand losing a great deal if issues arise and you are not able to repay the loan amount.
What Is Your Best Collateral Option?
Keep in mind, you do not have to go this route when applying for a business loan. While yes, traditionally speaking a bank is going to want collateral—collateral that you will most likely lose should a situation arise in which you cannot make your payments, there are other options available to you. That being said, if you do opt for a secured loan, only risk collateral that you can afford to lose. So, not, for example, your home.
There are ways though to get a loan without collateral. At First Union, we've worked with hundreds of small businesses, businesses that didn't necessarily have any collateral to put up against the loan amount. But because we are far more flexible than banks and have ample resources at our disposal, we were able to come up with a funding solution that worked for them. And we can certainly do the same for you. Call today!