Are you about applying for a business loan? If YES, here are 7 main types of assets typically used as collateral to secure short term business loans.
Every business organization needs adequate funds to help ease its growth. Whether a startup, a sole proprietorship, or a limited liability corporation, getting a small business loan can become one of your top priorities especially when you are looking to grow your company.
These loans can come from different sources, and each one will first scrutinize both you and your business to see if you are a viable borrower. For instance, a bank will look at your company’s history, business credit, revenues, balance sheet, and your equity contributions.
If you pass a credit check and you run a healthy business, most banks will also require an additional and tangible guarantee that their loan will be repaid, i.e., collateral.
What is a Collateral?
A collateral is an asset that is used to secure a loan. More or less, collateral is something of value that shows the lender you are willing to pay your loan. The business of lending money to businesses can be risky. Although most people and businesses have good intentions at the beginning, but sometimes things happen and they become unable to make their loan payments.
Few other times, there may be unscrupulous borrowers who do not plan to pay back the loan at all. With collateral, a lender can protect him or herself. Although for installment loans of a smaller amount, specific collateral is not needed. Collateral is generally not required for business loans like lines of credit, credit cards, and short-term loans.
A higher value (large) loan will almost always require collateral. Many lenders require loans exceeding a certain amount to be backed with commercial or personal real estate. Smaller loan amounts may not require specific collateral but will come with a personal guarantee or blanket lien requirement. Have it in mind that different types of loans also require different types of collateral.
For instance, the collateral for equipment financing is the equipment itself. An installment loan, on the other hand, may require the borrower to put up specific business assets or sign a personal guarantee. But it is very necessary to understand what collateral is required based on the loan you are pursuing. All collateral requirements will be discussed by your lender and included in your contract.
7 Main Types of Assets Typically Used as Collateral for a Short-Term Business Loan
- Real Property
The two key benefits of using real property as collateral for a small business loan are: 1) likely high worth and 2) readily available. Howbeit, if you default on a loan secured by real property, lender seizure of this asset is a major life-disrupting event. Nonetheless, if this is the biggest part of your net worth, losing something like a home will mean a big hit to your overall finances.
You can also secure a loan with your savings—otherwise sometimes known as a “cash – secured loan.” This method, which is most preferred by lenders, allows the lender to liquidate your collateralized account in the case of default. This makes sense since it is a direct value recoup for them—they do not have to go through the trouble of selling off an asset.
It is unbelievably risky to put up your entire savings as collateral, so consider your options extensively before collateralizing your cash. The benefit here is that since the lender views this as low risk, a small business loan collateralized by cash generally comes with better terms.
If run an inventory-based business and you are seeking inventory financing, the inventory itself can act as collateral in case of a default. Yes! This agreement is mostly straightforward, except if a lender does not view your inventory as resalable or highly valuable. Note that not all lenders will agree to secure inventory funding.
If you are seeking finance to hasten the purchase of a particular equipment, the actual equipment you are financing can act as collateral in this arrangement; especially since that particular equipment will actually affect the rate of your loan. That means that if the lender deems that whatever you are financing has a higher potential to retain its full value during liquidation in case of a default, you are likely to get better terms.
An invoice can work as collateral too, especially if you are seeking to release tied-up cash. Almost in the same vein, lenders can help borrowers finance invoices by collateralizing the actual invoice itself, and the lender will collect against the balance due on the invoice in the case of a default.
- Blanket Liens
Just like the word “blanket” implies, this type of collateralization is a pretty comprehensive one. And it is a lender’s best friend. A blanket lien gives the lender permission to repossess any—and every—form of collateral a business owns in order to get its money back. Be careful!
Under this arrangement you can lose everything if you default on your loan, and this will ravage your credit, meaning that securing a new business loan to pay off those existing debts could be really, really hard. Lenders want to be in the “first lien position,” meaning that if they’re offering a loan to a business with a blanket lien in place, that loan will probably be very expensive.
- Personal Guarantees
You can acquire a small business loan with a personal guarantee. Technically, this is not the same as putting up collateral, but the idea here is exactly the same—to secure the loan in case of default, lowering the risk for the lender.
Although with collateral, you are offering specific assets (a car, your inventory), but in a personal guarantee, as the loan’s co-signer, you are giving your creditors the right to seize any and all financial assets that you have now (or even those you will obtain down the road, depending on whether the guarantee is “limited” with a cap, or “unlimited”)
Often your lender requires collateral worth more than the amount of the loan, and will only accept a certain percentage of the value of that asset to secure the loan. Collateral value is determined by appraisal from a licensed expert during a “certified appraisal.”
Your lender will likely provide their own appraiser for valuation—though you are welcome to negotiate their findings either with your own appraiser or your own legal counsel if you think you have been undercut. However, before signing your loan paperwork, make sure that you fully understand what you are putting up as security and analyse your personal financial situation to ensure you are not stuck with a bad deal.