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Collateral Required for Different Business Loans

Collateral Required for Different Business Loans

When applying for a business loan, most lenders will require that you put up some form of collateral to secure the loan. Collateral acts as a secondary source of repayment if you are unable to make your loan payments. The type and amount of collateral required can vary significantly depending on factors like the loan type, loan amount, your credit score, and more.

What is Collateral?

Collateral refers to business or personal assets that you pledge to the lender if you default on the loan. If you are unable to repay the loan as agreed, the lender can seize the collateral, sell it, and use the proceeds to recover their losses. Common types of small business loan collateral include:

  • Real estate – Commercial property, vacant land, residential property
  • Equipment – Machinery, vehicles, office equipment
  • Inventory and accounts receivable
  • Cash savings – CDs, money market accounts
  • Investment accounts – Stocks, bonds, mutual funds
  • Personal assets – House, car, jewelry, etc.

Lenders prefer types of collateral that are easy to value and liquidate if needed. Putting up collateral also signals to the lender that you are willing to take on some risk yourself in order to secure financing.

Loan-to-Value Ratio

An important factor lenders consider when setting collateral requirements is the loan-to-value (LTV) ratio. This compares the amount of the loan to the appraised value of the collateral pledged. For example:

Loan amount: $100,000
Collateral value: $150,000
LTV ratio: $100,000/$150,000 = 67%

A lower LTV ratio signals less risk for the lender. Typical maximum LTV ratios are 50-90% depending on the loan type.

SBA Loans

Small Business Administration loans help entrepreneurs and small business owners get access to funding they may not qualify for with traditional lenders. The SBA guarantees a portion of the loan to the lender, reducing their risk.

Collateral required: SBA 7(a) and 504 loans may use business assets, personal assets, or both as collateral depending on the loan size and other factors. Low-doc SBA Express loans up to $25,000 do not require collateral.[1]

Conventional Bank Loans

Getting a term loan or line of credit from a traditional bank likely involves putting up collateral. Banks mitigate their lending risk by setting strict collateral rules.

Collateral required: Bank loans often use real estate, business equipment, and personal guarantees as collateral. LTV ratios of 80% or less are common.[2]

Alternative Online Lenders

Online lenders have emerged as an option for securing small business financing quickly and easily. Approval is based more on business performance data than collateral assets.

Collateral required: Many alternative lenders only secure loans with a blanket lien against business assets instead of specific collateral.[3]

How Much Collateral is Needed?

The exact collateral coverage a lender requires depends on multiple factors:

  • Loan type – SBA and conventional loans often require up to 100% collateral coverage. Alternative lender loans less so.
  • Loan amount – Larger loans typically need more collateral pledged.
  • Business credit/financials – Stronger profiles allow lenders to ease up on collateral requirements.
  • Collateral type – Easy to value/liquidate assets preferred (real estate, securities, etc.).

Talk to multiple lenders to shop around for the best collateral terms for your situation.

Using Personal Assets as Collateral

Some lenders allow or even require that business owners put up personal assets like houses, cars, investment accounts, etc. as collateral. This gives the lender recourse to seize those assets if the business defaults.

Before pledging any personal assets, carefully consider the risks involved. If the business fails and the lender liquidates your personal property, your finances and credit could take a major hit.

Collateral Tips

If your business needs to put up collateral for a loan, keep these tips in mind:

  • Work with lenders willing to accept assets you have available, even if less conventional collateral like accounts receivable or equipment.
  • Only pledge assets you could afford to lose as lenders will likely liquidate collateral in a default situation.
  • Ask the lender to release collateral as you pay down the loan principal.
  • Get assets appraised to ensure accurate valuation – don’t rely on your own estimates.
  • Read loan documents carefully to understand the lender’s rights regarding seizing and liquidating collateral.

Other Financing Options

If your business doesn’t have significant assets to pledge for a secured loan, consider alternative funding sources like:

  • SBA grants – Government grants don’t require repayment or collateral.
  • Crowdfunding – Raise funds by getting smaller investments from a large number of backers.
  • Angel investors – Get financing from high net worth individuals in exchange for equity.
  • Venture capital – VC firms provide funding to early-stage, high-growth startups.

Just keep in mind that these equity financing sources do take a portion of ownership in your company.

As you can see, collateral requirements vary quite a bit depending on your specific situation. Evaluate both the pros and cons of putting up assets to secure financing. And explore all of your business loan and funding options to find the best fit.

References

[1] U.S. Small Business Administration Loan Programs

[2] How Much Collateral Is Needed For A Business Loan?

[3] What is Collateral And Do I Need It For Business Loan?

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