Small business loans can be classified as secured or unsecured, depending on whether they involve pledging an asset as a precondition for borrowing.
Secured loans, also called collateralized loans, require pledging an asset known as collateral. They differ from unsecured or non-collateralized loans, which you can borrow without staking anything.
Secured loans are considered low-risk for the simple reason that a collateral is involved. In the event of default, lenders can legally repossess the pledged asset and liquidate it to repay the sum owed.
However, secured loans aren’t so attractive from a borrower’s viewpoint. Since you must pledge something in return, it’s important to understand the different assets lenders typically ask for.
This article shall highlight the seven most common collaterals associated with small business loan terms.
Understanding Small Business Loans
There are multiple collaterals you can pledge to obtain a secured loan. But before we delve into those assets, it’s important to address one frequently asked question about small business loans – how do small business loans work?
A small business loan refers to financing that helps to start a small business or improve the operations of an existing one. These loans are accessible to both aspiring entrepreneurs and existing small business owners.
Small business loans work nearly the same as other loan types. First, you’ll need to establish a need for financing. Low cash flow and high overheads are the tell-tale signs that your business could do with a small business loan.
The next step entails finding a suitable lender. This could be a bank or any credit company that offers reasonable lending terms, including high loan amounts and low interest rates.
Compare lenders while also reading reviews for more insights into their offerings. If all looks great, you can proceed to make a formal application for the loan.
Benefits of Secured Loans for Small Businesses
Despite their numerous perks for lenders, collateralized loans may also benefit borrowers.
Obtaining a secured small business loan gives you access to better lending terms, particularly a lower interest rate and longer repayment period.
Most lenders will also approve you for higher funding amounts if you opt for a collateralized loan. That’s due to the assurance that the company can always repossess the pledged asset and use it to repay the amount your business owes them.
Secured small business loans are also excellent for businesses with poor credit score and high debt-to-income ratio. That makes them particularly suitable for loss-making ventures.
How Do Lenders Determine Collateral Value For Small Business Loans?
Most lenders determine an asset’s worth by looking at its fair market value (FMV).
Fair market value is the price at which a commodity would easily change hands between a willing and informed buyer and seller. It’s calculated by examining the recent sale prices of the product or similar goods.
Resale value is another key factor that lenders use to compute a collateral’s value. A lender would want to know whether the pledged asset is likely to appreciate or depreciate.
There’s also the element of liquidity, or the ease with which an asset can be converted into cash. Examples of liquid collaterals include cash, stocks, and accounts receivables. Real estate properties, automobiles, antique jewelry, and long-term bonds are generally considered illiquid.
Different Collaterals for Small Business Loans
1. Real Estate
While common among mortgage borrowers, small business owners may also use real estate to secure loans. The tendency for real estate properties to appreciate makes this collateral option particularly suitable if you’re looking for higher funding amounts.
However, collateralizing a real estate property is imprudent if it’s your primary residential home at stake.
2. Business Equipment
Business equipment are low-risk collateral compared to real estate. The only downside is that your business may not have the right machinery to pledge depending on the funding amount you’re looking for.
This option is ideal for companies in the manufacturing or construction industries.
3. Business Inventory
Not to be confused with business equipment, inventory are goods currently in your stock.
Product-based business owners can pledge a portion of their inventory as collateral for a small business loan.
4. Cash
The primary reason you’re seeking a small business loan is that you’re cash-strapped. But if you have money stashed in the bank, perhaps in a high-yield savings account, you could use it to secure a loan.
Just remember that you’ll be unable to access the pledged percentage of your savings until you service the loan.
5. Investments
Investments like bonds and stocks can also help you obtain a secured loan.
Like cash, these assets are highly liquid, making them a preference for many lenders.
6. Invoices
Unknown to many small business proprietors, accounts receivables (or outstanding invoices) can be an invaluable asset when seeking funding.
Business owners can factor their invoices, which basically entails selling your accounts receivables to a factoring company. The company pays you most (if not all) of the outstanding amounts and then collects the balances directly from your customers.
7. Blanket Lien
Perhaps the riskiest collateral on this list, blanket lien gives a lender the right to seize any of your business assets in the event of a default.
You want to avoid this option unless you’re 100% positive of repaying the loan in time.
Wrap Up
Whether you’re seeking funding to meet immediate financial needs or scale your small business venture, it’s great to know that there are numerous assets you can collateralize.
Just remember to pick a collateral that doesn’t disadvantage your business while servicing the loan.
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