You have a great credit history, your business is bringing in solid revenues, your balance sheet is excellent and you have a solid business plan. So why does the bank want collateral before they’ll give you a business loan?
Because lenders aren’t willing to take on the risk of giving a small business a loan without yet more assurance that it will be paid back. And that means collateral, which the U.S. Small Business Administration (SBA) defines as "an additional form of security which can be used to assure a lender that you have a second source of loan repayment."
The collateral you use to secure a loan is typically tangible – unlike your credit history which doesn’t actually exist outside of a database. Collateral can be the home you own and occupy, other real estate holdings and property, your business’ inventory, your savings account, or business equipment. You can also use accounts receivable invoices or pending revenues to secure a loan. Banks tend to prefer assets that can be easy converted to cash – so your bank account is going to be much more attractive than something they have to sell at auction. And you may also be able to secure a loan with the item that you are financing with the loan – for example, if you’re getting a loan to purchase new equipment, you can probably use that equipment as collateral for the loan – assuming the equipment will retain its full value and is easily resalable.
Why should I secure a business loan with collateral?
The obvious answer is that you may not be able to get funding without collateral. But there are other reasons too. You may qualify for a bigger loan if you can secure it with collateral. You may also get lower rates. And collateral is likely to increase your chances of approval from a “maybe” to a “yes.”
Securing a loan with collateral also gives you some control over what happens if you can’t pay back the loan. If it is secured by specific collateral, you’re less likely to have to deal with a legal situation where the bank decides what they’d like to seize to recoup their loss – otherwise known as a general lien.
That said, it’s important to consider carefully what you can offer as collateral. Losing a home that your family lives in is a much bigger issue than losing investment property.
How much collateral is required for a small business bank loan?
Every loan agreement is different, but typically your collateral will exceed the amount of money you want to borrow. That’s because it’s unlikely that the lender will be able to get the full value of your collateral when it is liquidated – the collateral’s value may depreciate, or the lender may have to accept a lower price to liquidate it quickly. So, your $70,000 loan may require $100,000 in real estate collateral. If you’re securing the loan with something like inventory, you’re likely to get only 50% of the actual value of your inventory – so a $50,000 loan would require at least $100,000 in inventory as collateral. These figures assume the business has a good cash flow, and is very healthy. If your business is new, or is struggling financially, you’ll have to provide more collateral.
Options to Traditional Bank Loans
Alternative funding sources provide options for small businesses who don’t qualify for traditional loans, as well as faster access to funds compared to bank loan approval times. And, even if your credit score isn’t great, you will probably be able to access funding even without securing the loan with collateral.
As an example, a merchant cash advance enables smaller businesses to access funding quickly. And since MCAs are not loans - they are an advance against a business’s future income - no collateral is needed. The funder provides a lump sum advance on the merchant’s future revenues. The advance is then repaid from a set percentage of the merchant’s actual revenues. For example, if the set percentage is 10%, and the day’s revenues total $5000, then the repayment amount for that day is $500. On another day, when revenues are $1,500, the repayment amount would be $150. Repayments are automatically withdrawn until the advance and any associated fees and interest is paid back.
Typically, merchant cash advances were available to small businesses such as stores or restaurants that were paid primarily by credit or debit card. Funders were paid back directly from payment card receipts. MCAs can now be paid back by remitting the agreed upon percentage from a business bank account through ACH (Automated Clearing House) withdrawals. You no longer need to be a “merchant” to get a merchant cash advance.
Another option is Accounts Receivable Financing, also known as Invoice Financing/Factoring. Many small business owners have experienced the stress of waiting 30-90 days for their invoices to be paid. An invoice financing loan provides expedited access to those funds. The small business owner gets an advance on the money due, the lender later collects the amount, plus fees and interest. Depending on the agreement, the funder will collect the money directly from the company that owes the money (e.g.: the small business’ customer) or the small business owner is responsible for collecting on the invoice and paying back the advance along with fees and interest.
How to qualify for a small business funding
One easy way to get started is by getting pre-approved by One Park Financial, which then gives you access to a funding expert who can discuss your business needs and options to determine what funding types best meet your needs.
One Park Financial works to help owners of small and mid-sized businesses access the funding that meets their needs. Established in 2010 and founded by entrepreneurs, One Park Financial understands the challenges associated with small business loans and their need for working capital. Visit oneparkfinancial.com or call 855.218.8819 and connect with a funding expert to discover the options that make sense for you and your business.