Can you get a small business loan without collateral? There are several options for small business owners who need funding but cannot provide collateral.
It is not unusual for small business owners nationwide to resort to business financing options for various reasons. After all, they can only pay out of pocket for so long. Small business loans can provide the support they require, whether they need business funding for sudden bulk purchase orders, supplementing cash flow, business capital, or making up for income losses.
But often, a traditional lender would require collateral, whether it is for a business loan or a personal loan. This condition can be an impediment considering that many businesses, big and small, have either closed down or continue to struggle with debt due to income loss and recent economic restrictions. Can these impacted businesses looking for the right financial partner to work with their specific needs still get a small business loan without collateral? Let’s find out.
What are small business loans?
Small business loans are lending instruments catered to small and medium enterprise needs. A lender provides funds conditionally to the borrower plus interest. Over time, small business loans have evolved to adapt to the changing needs of entrepreneurs. There are term loans, SBA loans, equipment financing, to name a few.
Why do business loans require collateral?
Commercial lenders and banks look at every borrower regarding how much risk they present. They offer loans that usually involve personal or business assets such as real estate property as a collateral requirement. It is one form of assurance to the lender if the business defaults because they can repossess the collateral to cover the outstanding balance. This setup describes how traditional secured loans work.
Also referred to as a collateral business loan, there are other examples of a secured loan. Equipment financing is where the equipment purchased using the loan proceeds will serve as collateral for the transaction. On the other hand, invoice financing uses the unpaid invoices of the company as collateral.
The collateral value should be more than the borrowed funds to satisfy the lender requirements. Business owners can loan up to 90 percent of this value. The bank determines the loan-to-value (LTV) ratio of the physical asset, which dictates the maximum loanable amount to the small business owner. For commercial real estate property, as an example, you can acquire a business loan of up to 70% of its appraised amount.
As such, putting up collateral from a borrower’s end should not be taken lightly. You don’t want your lender seizing your property which you have likely worked hard to acquire. Lenders consider this reason, knowing you have more skin in the game, so they are more confident when it is a collateral business loan. They would protect their interests first because nothing more can appease them than having collateral as a “just in case” despite the strict vetting process. It also enables them to provide their clients with more competitive interest rates. Another reason for this collateral requirement is that some lenders would like to tap clients with less than favorable business credit scores.
Pros and cons of secured loans
High loan approval odds
You can avail of practically any type of small business loan with collateral requirements for as long as it is proportionate to your business assets. If you are presenting a piece of real estate as collateral, you can get its value from an appraiser, which you can show to your potential lender.
Compensates for low business credit scores
As mentioned, a secured loan allows lenders to mitigate the risk of loaning funds to someone who falls short of their preferred credit score. It could mean a score of 680 or thereabouts, which is several points below the usually acceptable score of 700. Hence, it may be lower than the target but not too low to be considered a bad credit, which otherwise would have even more limited options.
Lower interest rates
Banks can offer loans with collateral at a lower rate than a no-collateral small business loan. The personal asset acts as a buffer, providing confidence and guaranteeing that the lender can still collect any unpaid outstanding balance through liquidating such assets.
Increased negotiating power
When borrowers can provide collateral for their loan, they can have lower APRs and better loan terms, such as a longer repayment period or a higher loanable amount.
Improved personal credit score
Once you complete a secured loan without fail, it will benefit your personal credit score tremendously. It sends a signal to future lenders how you have responsibly handled your credit, making you an attractive client.
Repossession of property in case of repayment failure
Anything can occur during the loan duration; you can become sick or lose money in your business, which causes you to fall behind on your monthly amortizations. You then know what happens next when you don’t pay – you lose your property to the lender.
While cash-backed deposits and stock certificates can serve as collateral, they are often insufficient to cover your desired loan amount. Banks would often match the value of the deposit and will still require additional assets before granting loan approval.
Alternatives to collateral
Sometimes it’s difficult for banks to waive the collateral requirement. While they would rather take tangible assets, the truth is, there are other forms of security you can offer to your lender aside from collateral.
In place of collateral, a borrower may sign a blanket lien where the lender will have control of all business assets when unable to fulfill their loan obligation. This condition means that although there is no collateral, any business asset in the form of inventory, equipment, property, accounts receivable, etc., may be seized in proportion to the owed money. It is covered under the Uniform Commercial Code or UCC, standardizing US commercial transactions.
This option is about the personal assumption of liability for a small business loan. As with business loans, the business itself is the debtor, and in case of default, the person who owns the business will not be affected credit score-wise. When you sign a personal guarantee, you waive this boundary such that, whatever your business owes, you also owe it as a private individual. The bank is empowered to come after personal assets, which extends to your family assets if you are married.
When you need a little more funding, but your personal and business qualifications fall short, you can present a guarantor or cosigner for your loan. This option will only be valid if your cosigner has a high personal credit score. While it may not be as easy to find someone willing to risk their good credit reputation, once you do, you can enjoy benefits such as a low APR and higher loanable amount.
Small business loans without collateral (unsecured business loans)
We know that to get the lowest rates possible, secured loans will most likely give them to you. But the reality is most small businesses don’t have qualified assets. And when some of them do, they still would prefer unsecured business loans because they don’t want to risk their properties. And often, clients would feel that the banks are undervaluing them.
Thankfully, not all small business loans require collateral. Lenders are taking a bigger risk lending money this way; however, they make up for it in other ways by setting stricter terms and higher interest rates.
Below are examples of unsecured business loans offered by banks and alternative lenders, which you can consider when you are unable (or prefer not) to provide collateral.
Like a regular mortgage, albeit without presenting collateral, a short-term loan is granted up to five years and is typically used to fund business investments. It follows an amortization schedule where several mortgage payments are applied to the interest before the principal. It might be challenging for a bank to provide you with this loan compared to online lenders.
SBA loan (Small Business Administration)
SBA loan programs have the backing of the Small Business Administration federal agency, which supports growing businesses. The agency will cover between 75% and 85% of the outstanding balance in the event of non-payment of the borrower. Attractive as it may be, this type of unsecured loan is tough to get given the stringent requirements and longer processing.
Business working capital loan
This loan caters to funding daily operations such as payroll, rent, etc., instead of paying for major business expenses or investments. It is linked to personal credit and features short loan periods and smaller amounts.
Business line of credit
This type of business financing might very well be the best no-collateral option there is. However, very few banks will offer it to you; hence you can access more of them from online lenders. An unsecured business line of credit is ideal for startups who often need recurring funding, which works by giving you a credit pool you can tap into at your disposal. You will pay back whatever amount you take out from this credit line plus interest. Any repayments you make are put back into your credit line.
Business credit card
Perhaps the simplest way to secure financing for your business, especially if you require minimal funding, business credit cards can be a useful tool to get small businesses up and running. The process of getting one is quicker and lends you more flexibility. While it works similarly with lines of credit, you can enjoy better rates. You can even take advantage of several card companies’ introductory zero APR promotions.
Merchant cash advance
Also known as a cash advance loan, a merchant cash advance provides a lump sum that you will repay using a percentage of your credit card sales or debited from your business bank account. Retailers, for example, get to pay according to their actual revenues without impaling them whenever the sales income is low. However, you may consider a merchant cash advance a last resort due to their high-interest rates presented as factor rates.
Other non-collateral small business loans
Other unsecured loans can come with some form of guarantee as they are essentially self-securing. Such loans include accounts receivable financing or invoice financing and equipment financing. The unpaid invoices and the purchased equipment serve as collateral without requiring the borrowing to present any existing asset.
Pros and cons of a small business loan without collateral requirements
Having no collateral is one less worry
As mentioned earlier, many more small businesses can use a loan without this demanding requirement that most of them may not be able to come up with. In case you have one but don’t like to use it, you avoid the risk of losing it to your creditor when you could no longer pay for some reason.
Higher profits (for the lender)
While riskier for the lender, they also benefit from high-interest rates with higher returns for their money when loans of this nature are fully paid without a hitch.
Faster application processing
Both secured and unsecured business loans entail strict vetting by traditional lenders. But without the collateral, which otherwise takes additional time examining it and determining its value, an unsecured loan is processed a lot quicker. The proceeds are released faster, which is always favorable to the debtor who may need these funds immediately.
Flexible repayment terms
An unsecured loan that business owners can access on an “as needed” basis allows them to repay them in full at practically any time they can do so to minimize their accrued interest. Every cycle, a minimum payment is required to ensure the borrower can fulfill their loan obligations and build their credit history in the process.
We know by now the risks on the lender’s side when it comes to financing loans without collateral. As such, it is compensated with higher than average rates.
Since the borrower does not have collateral, the lender will require documents to substantiate the application and minimize risk. It is why it would be harder to qualify for an unsecured business loan. A high personal credit score will be required for those who don’t have established businesses yet.
Lower loanable amount
Still associated with risk management, a commercial lender will be more conservative than an alternative lender with no collateral. Hence, an unsecured business loan can only help you with moderate funding at most. It cannot likely finance expansion projects and sizable purchase orders.
Steps in applying for an unsecured business loan or loan without collateral
1. Choose which type of unsecured business loans best caters to your needs and qualifications. Talk to potential lenders and ask all pertinent questions. Discuss with your financial advisor as well.
2. Verify your personal or business credit scores from credit bureaus and other financing companies that offer them for free.
3. Depending on the amount you will need, get ready to sign a personal guarantee or a blanket UCC lien to satisfy your lender’s requirements.
4. Decide which lender you have the highest loan approval odds and meet your financing needs, and submit your documentation after that.
5. Once your loan application is approved, read the terms and conditions of your contract, most especially the fine print, carefully before sealing the deal.
Final thoughts on non-collateral small business loans
Small business owners are equipped with tools to help them succeed with the help of financing, even without collateral. But first, ask yourself why you are seeking funds and how confident you will be able to fulfill them without fail. Remember that having no collateral does not make it easy for you not to pay your debts. What happens after that will impact your creditworthiness in the future.