Why Collateral Matters When Getting a Small Business Loan

Business.com / Funding / Last Modified: February 22, 2017

Getting a small business loan isn't a cakewalk; but there's a few things here that might make it easier for you to get one.

Everyone in small business knows that cash flow is the blood that runs your business.

Sometimes, you’ll have times where your cash-flow is in doubt.

You might need a loan at that point to keep you going until your debtors pay you what you’re owed. You might also need a loan if you’re looking to expand or buy necessary assets for your business.

Again, you won’t want to jeopardize your cash flow in order to buy assets.

As you’re most likely aware, you can get commercial loans for your small business. But those loans come with a risk. Not just to you, but also to the lenders. That’s why most small business loans include something called collateral.

Related Article: Will Work for Funding: 7 Ways to Finance Your First Small Business

Essentially, the bank or lender is putting up the money for you to expand or pay your workers. You agree to pay them back. However, if you don’t make the money in the future, they lose their money. In order for it not to be a complete loss for your lender, you give them “collateral.” This means that in the event you don’t pay your loan back with the interest written in the contract, that the lender has an asset (or something similar) of yours which is worth the value of the loan, or at least relative to it. Often, this collateral is real estate, assets or even stock.

We’ll focus on the different types of collateral available to you in a wide variety of areas.

Small Business Loans: How They Usually Work

There are two types of loans generally available to small businesses. These are bank financed loans, and loans by private investors. These are not to be confused with something called Angel investors, who tend to buy a piece of the company in exchange for capital. Essentially, they are private individuals who are looking for rates of return better than a savings account.

As such, you know that the amount of interest you’ll be paying back will be greater than the interest on a general savings account. This figure is generally between seven and eight percent for small business loans, yet rarely ever reaches the ten percent mark or above. Loan terms can range from as little as a year or two right up to twenty years, depending on the investment.

What Works as Collateral?

Collateral will work differently depending on what you own, what your company owns, what sort of loan you are going for, and the terms of that loan. It’ll also depend on what your background is in business and the amount of money you both have on hand, and are looking to borrow from your lender.

Say you have a business that is a bar and restaurant. You could use the restaurant itself (should you own it) if you’re looking for a huge loan. It’s not recommended – in the same way as someone refinancing their home to get a new car, you run the risk of losing the business. However, if you are expanding to several locations, perhaps a loan collateral of one building is worth the risk.

For smaller figures, you could get a loan based on revenue. This is called a working capital loan. This is a short term loan, and will be based upon the amount of revenue your business takes in. This is good if you have a short-term cash flow issue; however, let’s talk about some of the more common collateral items.

Related Article: To Borrow or Beg: Small Business Funding in 2015

Debt

Many small business loans are short term. They are due to cash flow, which is why we mentioned it in the very first sentence of this article. According to Frank Kasimov of BusinessLenderMatch.com, “Very few people understand that the money you are owed is an asset in accounting terms. That is money you’ve earned, but have yet to receive. This will make all the difference when it comes to securing business loans, as this money is what you can use to pay the loan back.”

Home Equity

Many business people refinance the mortgage on their homes in order to free up cash. This is a way of gaining a substantial amount of funds quickly. That said, it should always be discussed with family members before being undertaken – after all, you have to put your own home on the line. This is an extreme way of refinancing unless the money for the future is secure (should you be using the money to buy the infrastructure for a contract which you’ve already obtained.)

Vehicles

Vehicles are a common way to obtain a small business loan, as they have a relatively easy to calculate value. This can extend to commercial vehicles, not just your family car. This is particularly useful for delivery or logistics companies, who tend to have a lot of money in their vehicles. It’s worth noting that this is better for edgier investments, as vehicles are a depreciating asset anyway, and are losing value all the time. Using them as collateral makes the most out of the time that they last for.

Related Article: Capital Continues to Elude Small Businesses: What Can be Done?

Business Inventory and Equipment

Anytime you have stock, this can be considered an asset whilst it is sitting in your store. This can then be used as collateral when it comes to securing a small business loan. Similarly, the machinery and equipment your business has can also be considered collateral. Collateral usage is another way of earning money from your fixed assets.

If you can prove that you have the money coming in, then you should have no trouble securing a loan. It’s the reason that banks want you to write a business plan before you start a business in order to get funding with them. As always, planning is very important – especially when it comes to small business loans. Many people start a business to be their own boss, yet when you borrow money, you are responsible for someone else’s money as well. That’s why you need to plan ahead

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