What Kind of Collateral Do I Need for a Business Loan?

 
05/01/2019



You have a vision and you want to apply for a small business loan to bring it to pass. Congratulations! This is an exciting moment for any entrepreneur.


Yet you may soon find out, if you haven’t already, that finding and qualifying for the right small business loan isn’t always easy. Between gathering the small mountain of documents you’ll need to supply and deciphering each lender’s qualification (and collateral) requirements, applying for a business loan can be quite confusing.

One fact is certain – the more prepared you are when you apply for a small business loan, the better your chances of being approved.

Here are four simple steps to get ready for your business loan application.

  • Look at your situation honestly.
  • Create a solid business plan.
  • Find the right financing option and lender.
  • Gather your documents.

1) Look at your situation honestly.

Before you can qualify for a commercial loan, you’ll need to prove that doing business with your company is a good risk. This means you’ll need to pass successfully through a lender’s qualification process.

Factors you should consider (because they will matter to lenders) include:

  • Is your business and personal credit in good shape? – You can be sure that the condition of your credit is going to matter whenever you apply for a new small business loan. If you haven’t checked your business and personal credit lately, you can access this information by setting up a free account with Nav. Bad credit isn’t necessarily a deal killer, but credit score problems could mean fewer financing options available.
  • How long have you been in business? – If your business is young, qualifying for certain types of loans can be challenging. A startup loan may be the best place for you to search for initial funding.
  • Do your business financials look good? – A thriving company with solid financials is more likely to qualify for attractive terms from lenders. A struggling company, on the other hand, may need to look at alternative funding options and might have difficulty qualifying for financing at all.
  • Are you willing to put up collateral to secure financing? – Depending upon the type of financing you need, a lender might ask you to put up assets (aka collateral) to secure a loan. Collateral requirements may be satisfied with equipment, real estate, accounts receivable, and even personal property. (See below for answers to frequently asked questions about collateral.)
  • Is a personal guarantee something you’re comfortable providing? – Another way that lenders can reduce risk is by making sure that you, the business owner, have some skin in the game. If you’re willing to put your personal name on the line to secure financing, it can make lenders feel better about your likelihood to repay the loan (especially if you have good personal credit).
  • Why do you want to borrow money? – When you apply for a loan you need to know specifically what you plan to use the money to accomplish. You can bet lenders will want to know your plans with the money you’re applying to borrow as well. Having a good answer to this question could be the difference between an approval and a denial.

2) Create a solid business plan. 

Part of convincing a lender that loaning your business money is a good risk involves demonstrating that you have a solid plan for the future of your company. A good business plan should contain:

  • A sound description of what your business does, who it serves, and how you stand out among the competition in your industry. The Small Business Administration (SBA), for example, requires your business to have a “sound business purpose” to be eligible for financing.
  • Short and long-term goals you’ve set for your company in terms of annual revenue and profit.
  • How much financing you need to reach your goals and the specific ways you plan to invest the money you borrow to help your company succeed.

Ready to create a business plan of your own? Here’s a step-by-step guide.

3) Find the right financing option and lender.

Determining which financing option and lender is the best fit for your company is more complicated than it seems on the surface. There are over 44 different types of business financing including:

  • Business Credit Cards
  • Business Lines of Credit
  • SBA Loans
  • Startup Business Loans
  • Microloans
  • Business Loans Without Collateral
  • Peer-to-Peer Lending
  • Asset-Based Financing
  • Short-Term Loans
  • Long-Term Loans
  • Accounts Receivable Financing
  • Bad Credit Business Loans
  • Invoice Factoring
  • Seller Financing

In addition to 44+ types of financing, there are hundreds of lenders (including banks, online lenders, and more) who offer various financing options to businesses. It can be overwhelming to simply identify the right loan program. Finding the best deal among hundreds of small business lenders can feel downright impossible.

Nav’s online marketplace can help you to filter through the noise and find the best financing options available, based on your credit and other factors.

4) Gather your documents.

Once you’ve chosen your preferred lender and loan product, it’s time to gather up the information you’ll need to complete a loan application. Every lender is different, but most have common documentation requirements such as:

  • Tax returns (business and personal, generally for the past 1-2 years)
  • Bank statements (business and personal, generally for the past 6-12 months)
  • Profit and loss statements
  • Existing business debts
  • Incorporation paperwork
  • Employer Identification Number (EIN)
  • DBA registration, if applicable
  • Business licenses and permits
  • Proof of collateral

Frequently Asked Questions About Collateral for Business Loans

Keep reading to learn about how collateral can help you secure a loan, what types of collateral lenders may accept, and how to possibly avoid the requirement altogether.

Do I need collateral for a business loan?

A simple definition of collateral is an asset you promise a lender if your business can’t pay back the money it borrows. In the event of a loan default, the bank can take ownership of the asset and sell it to recuperate some of its lost funds. These types of loans are sometimes called “secured” or “collateral loans on property.”

Many banks require business loans to be completely collateralized. So, if you want to borrow $50,000 for your business, you’ll need to put up $50,000 worth of assets to back the loan.

Before any lender agrees to let your business borrow money, it needs to be sure that the loan represents an acceptable level of risk. Collateral matters to lenders because it reduces risk – perhaps significantly.

Is it possible to get a business loan without collateral?

It’s possible to get some business loans without collateral, but the financing may be more difficult to obtain (and more expensive).

Unsecured loans are riskier for lenders to issue. As a trade-off, you might have to provide a personal guarantee, borrow less, and/or reduce a lender’s level of risk in other ways. If you want to avoid a collateral loan, it helps if you have other factors working in your favor.

When you apply for financing, the lender will use a system to evaluate your risk and creditworthiness and determine whether it wants to take you on as a new customer. This system is commonly referred to as “The 5 Cs of Credit.”

The factors lenders typically consider in the “5 Cs” system include:

  • Character – This is typically your credit history (business credit, personal credit, or both).
  • Capital –Does you have working capital (aka business assets like equipment, inventory, or cash which outweigh your company’s debts)? Did you or others invest personal money into your business? If yes, these can make your business appear stronger in a lender’s eyes.
  • Capacity – Lenders may evaluate your cash flow to make sure your business is earning enough to cover debts and expenses, along with any new monthly payments.  
  • Conditions – What is the current condition of the economy and your industry? Is your company able to survive an economic decline? These are questions lenders may consider when evaluating your loan application.
  • Collateral – When you apply for business financing, you may qualify for better terms by securing the loan with assets or cash.  

The stronger your application is in the other areas, the better your chances of qualifying for business financing with no collateral requirements.

Additionally, certain types of financing are less likely to require collateral, such as:

What can be used for collateral to secure a business loan? / What kind of collateral do you need for a small business loan?

While every lender is different, here are some common types of collateral which a lender might accept to secure a business loan:

  • Real Estate
  • Accounts Receivable
  • Cash Deposit/Savings
  • Equipment
  • Inventory
  • Personal Property (e.g. Homes, Vehicles, Retirement Savings, etc.)

Sometimes the asset you’re borrowing money to purchase can serve as collateral for its own loan. For example, if you borrow money to buy a commercial warehouse, the property itself could be seized by the bank and resold if needed.

Also, the better the collateral you put up, the higher the loan amounts lenders may be willing to give you. When you back a loan with cash deposits or savings, for example, a bank may be willing to let you borrow between 95%-100% of that amount.

Banks may loan you money based on other types of collateral too. However, if you put up inventory or some riskier form of collateral (from a bank’s perspective), you might not be able to borrow as much. You also might need to find additional sources of collateral and stack them together to back the loan.  

When you put up collateral like equipment, inventory, or even real estate, the bank will do its own valuation of what the asset is worth. You might believe a piece of equipment is worth $50,000, but a bank could estimate the value to be far lower. It’s probably a good idea to have an independent appraiser give you an estimate on the value of the asset you want to put up before you apply for a business loan.

Types of Collateral Loans for Businesses

Secured Business Loans for Bad Credit

A secured business loan is another name for a loan backed by collateral which reduces the lender’s risk. Collateral can be especially important when you or your business have less-than-stellar credit.

A few examples of secured business loans for bad credit include:

While these types of loans may be easier to qualify for with bad credit, they’re generally much more expensive for the borrower.

Trying to build your business’ credit rating? Consider a secured business credit card. By providing a cash deposit upfront, you reduce the lender’s risk and may be more likely to be approved, even with credit problems.

Secured Startup Business Loans

Getting funding for a new startup business can be especially challenging. Most banks have strict lending criteria and will require a business to be established (and profitable) before issuing a new business loan.

There are, however, several small business startup financing options available to newer businesses. These include:

SBA Loan Requirements

An SBA loan represents one of the most affordable ways for business owners to borrow money. But affordability comes with a tradeoff; SBA loans feature notoriously strict approval criteria which can be difficult to satisfy.

Some of the most common requirements your business will have to meet to qualify for an SBA loan include:

  • You must sign a personal guarantee.
  • You and your business must have decent credit.
  • Cash flow must be sufficient to satisfy a lender.

The collateral requirements on SBA loans, can also be a bit steep. To secure funding through an SBA loan, small business owners are commonly required to put up a mix of business and personal assets – often including the business owner’s personal home.

Interested in applying for an SBA loan? Here’s a step-by-step guide to help you navigate the process.

SOURCE: https://www.nav.com/blog/what-kind-of-collateral-do-i-need-for-a-business-loan-39838/




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