If you need help financing your business goals, a
small business loan can give you the capital you need. But to get it, you may have to provide collateral.
Some lenders require collateral for their loans, especially if your company has a limited or poor credit history. Even if you apply for a loan that doesn’t require collateral, you may still want to provide it since it could help you qualify for a better interest rate and terms.
What is business collateral?
Business collateral is an asset or assets that a business owner promises to hand over to a lender if they fail to repay the loan. Collateral acts as security for the loan.
When you provide business collateral, you reduce the risk that a lender will have to go away empty-handed. Since the lender has this assurance, it’s more likely to approve a loan and may even offer better rates and longer repayment terms. Collateral can even help business owners with bad credit qualify for a loan.
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How business collateral works
When you sign closing documents on your loan, you will sign a lien agreement for the property you use as collateral. This agreement clarifies the lender’s right to your property to recoup their costs if the loan goes unpaid. The collateral will remain in your possession as long as you stay current on your loan payments.
Lenders generally want enough collateral to offset 100% of what you are asking to borrow. Your property value will be assessed, usually compared to similar property that has recently sold.
Assets are usually assessed based on the stability of their value (vehicles depreciate quickly, as one example; real estate, by contrast, tends to appreciate over time). Marketability and transferability also factor into assessed value: lenders prefer assets that would be easy to offload if necessary.
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If you need to catch up on payments, your lender is likely to contact you before repossessing your collateral. Once your loan is fully paid, your lender should provide you with a lien release, relinquishing any rights they had to the property under the conditions of the loan.
Types of business collateral
Here’s a look at some common types of business collateral.
Real estate
If your business owns real estate, this can serve as collateral when you borrow. This type of asset may include a home office, other buildings or land belonging to the company. Real estate is typically a strong form of collateral to offer because of its sizable and stable value.
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Business equipment
Many types of equipment and machinery can fall under this umbrella, including office equipment, semi trucks and heavy machinery.
Lenders may be picky about this form of an asset as collateral: the older or more heavily used your equipment is, the less value it has to a lender. Similarly, if your equipment is niche to your industry and would be difficult for your lender to offload, it may be less valuable as loan collateral.
Inventory
Unsold inventory can serve as loan collateral for your business. Especially if you operate in the retail sector, you may find this a valuable asset to offer. As with specialized business equipment, lenders may consider certain kinds of inventory to be more desirable than others, so keep in mind that your valuation may differ from your lender’s.
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Investments
If your business owns any stocks, bonds, or other investments, these are generally considered strong collateral. Like cash, these assets are easy to value and liquidate, so they are ideal if you can tolerate the risk associated with using them to secure your loan.
Cash
Only some lenders will consider cash as loan collateral, but it is the most straightforward asset you can offer. Business bank accounts like checking and savings may be where you keep cash assets, in which case acquiring documentation should be easy.
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Invoices
When you use an invoice financing company, you are securing a loan using unpaid or outstanding, invoices. This type of business loan can be costly, and you will miss out on the chance to get full value for your unpaid invoices. But this is a fast way to secure financing, which can save you from having to wait 30, 60 or 90 days for an invoice to get paid.
Blanket lien
A blanket lien is appealing for lenders but very risky for borrowers. This type of collateral can give your lender broad authority to seize multiple assets if your loan goes unpaid, sometimes up to or including all of your business assets.
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Pros and cons of business collateral
Pros
- It is possible to qualify for a secured loan with fair or even bad credit.
- Collateral can lower the rate or improve the terms of your loan.
- May increase the amount you qualify to borrow.
Cons
- Your application may take longer to process than one for an unsecured loan.
- You risk losing your collateral if you fall behind on payments.
Bottom line
If you can tolerate the risk of potentially losing assets, offering business collateral can be a great way of qualifying for a loan you may not otherwise be able to secure. Plus, because lenders invest less risk in secured loans, they may offer better interest rates and repayment terms in exchange for the lien on your collateral.
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Frequently asked questions
How much collateral do you need for a business loan?Caret DownGenerally, lenders look to secure your loan using collateral equal in value to (or greater than) the amount you are applying to borrow. Your lender may not value your collateral in the same way as you do, so be prepared for an estimate of only 80% or 90% of the fair market value of your asset.
Can you get a business loan without collateral?Caret DownYes, unsecured business loans are available. They may require a longer and stronger financial track record and excellent credit to be approved, but not all loans require collateral.
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What are the pros and cons of asset-based lending?Caret DownAsset-based lending refers to a loan or line of credit that is secured by collateral. Generally, secured loans and lines of credit offer more advantageous borrowing terms for business owners and less risk for lenders than unsecured debts. Conversely, this type of loan generally requires more time and documentation than unsecured loans, both at closing and once the loan is paid off. For borrowers, asset-based lending can be a high-risk gamble that puts their business operations at risk.
