What is business collateral?

If you need help financing your business goals, a small business loan can give you the capital you need. But to get it, you may have to provide collateral.

Some lenders require collateral for their loans, especially if your company has a limited or poor credit history. Even if you apply for a loan that doesn’t require collateral, you may still want to provide it since it could help you qualify for a better interest rate and terms.

What is collateral for small business loans?

Collateral for a small business loan is an asset or assets that a business owner promises to hand over to a lender if they fail to repay the loan. Collateral acts as security for the loan, which is why these types of loans are sometimes called secured business loans. Unsecured loans don’t require collateral.

When you provide collateral for business loans, you reduce the risk that a lender will have to go away empty-handed. Since the lender has this assurance, it’s more likely to approve a loan and may even offer better rates and longer repayment terms. Collateral can even help business owners with bad credit qualify for a loan.

How business collateral works

There are several things to know about using collateral to secure a loan.

• When you sign closing documents on your loan, you will sign a lien agreement for the asset you use as collateral. This agreement clarifies the lender’s right to your property to recoup their losses if the loan goes unpaid. The collateral will remain in your possession as long as you stay current on your loan payments.
• Lenders generally want enough collateral to offset 100 percent of what you are asking to borrow. If you use real estate as your collateral business asset, for example, your property value will need to be equal to or greater than the loan amount.
• Lenders will consider the stability of an asset’s value when considering it for collateral. For instance, vehicles depreciate quickly, while real estate tends to appreciate over time.
• Marketability and transferability also factor into assessed value. Lenders prefer assets that would be easy to offload if necessary.
• If you need to catch up on payments, your lender is likely to contact you before repossessing your collateral. Once your loan is fully paid, your lender should provide you with a lien release, relinquishing any rights they had to the property under the conditions of the loan.

Collateral vs. personal guarantee

Collateral in business loans refers to business assets or things your company owns. But if your business doesn’t have sufficient assets to serve as collateral, or if the lender just wants an extra safeguard built in, they might ask for a personal guarantee.

A personal guarantee means the lender can pursue not just your company for repayment but also you personally and can seize your personal assets if you default.

Types of business loan collateral

Here’s a look at some common types of collateral used in business loans.

Real estate

If your business owns real estate, this can serve as collateral when you borrow. This type of asset may include a home office, other buildings or land belonging to the company. Real estate is typically a strong form of collateral to offer because of its sizable and stable value.

Business equipment

Many types of equipment and machinery can fall under this umbrella, including office equipment, semi trucks and heavy machinery.

Lenders may be picky about this form of an asset as collateral: the older or more heavily used your equipment is, the less value it has to a lender. Similarly, if your equipment is unique to your industry and would be difficult for your lender to offload, it may be less valuable as loan collateral.

If you get an equipment loan, the equipment you’re buying will usually serve to collateralize the loan.

Inventory

Unsold inventory can serve as loan collateral for your business. Especially if you operate in the retail sector, you may find this a valuable type of business asset to offer. As with specialized business equipment, lenders may consider certain kinds of inventory to be more desirable than others, so keep in mind that your valuation may differ from your lender’s.

Investments

If your business owns any stocks, bonds or other investments, these are generally considered strong collateral. Like cash, these assets are easy to value and liquidate, so they are ideal if you can tolerate the risk of using them to secure your loan.

Cash

Only some lenders will consider cash as loan collateral, but it is the most straightforward asset you can offer. If your business keeps its cash assets in business bank accounts like checking and savings, acquiring documentation should be easy.

Invoices

When you use an invoice financing company, you are securing a loan using unpaid or outstanding invoices. This type of business loan can be costly, and you will miss out on the chance to get full value for your unpaid invoices. But this is a fast way to secure financing, saving you from waiting 30, 60 or 90 days for an invoice to get paid.

Blanket lien

A blanket lien is appealing for lenders but very risky for borrowers. This type of collateral in business loans can give your lender broad authority to seize multiple assets if your loan goes unpaid, sometimes up to or including all of your business assets.

Pros and cons of business collateral

Pros

• Potential to qualify for a collateralized loan with fair or bad credit
• Collateral may lower the rate or improve loan terms
• May increase the borrowing amount

Cons

• Application may take longer to process due to collateral assessment
• Risk of losing collateral if you default on loan

What to do if you don’t have collateral

If your business doesn’t have anything that could serve as collateral — or you just don’t want to put anything on the line in case you can’t repay what you borrow — you have other options:

Bottom line

What is business collateral? It’s something you put on the line that your lender can seize if you don’t repay your business loan.

If you can tolerate the risk of potentially losing assets, offering business collateral can be a great way of qualifying for a loan you may not otherwise be able to secure. Plus, because lenders take on less risk with secured loans, they may offer better interest rates and repayment terms in exchange for the lien on your collateral.

Frequently asked questions

• How much collateral do you need for a business loan?

  Generally, lenders look to secure your loan using collateral equal in value to (or greater than) the amount you are applying to borrow. Your lender may not value your collateral in the same way as you do, so be prepared for an estimate of only 80 percent or 90 percent of the fair market value of your asset. A business loan calculator can help you see how much you may have to put down.

• Can you get a business loan without collateral?

  Yes, unsecured business loans are available. They may require a longer and stronger financial track record and excellent credit to be approved, but not all loans require collateral.

• What are the pros and cons of asset-based lending?

  Asset-based lending refers to a loan or line of credit that is secured by collateral. Generally, secured loans and lines of credit offer more advantageous borrowing terms for business owners and less risk for lenders than unsecured debts. Conversely, this type of loan generally requires more time and documentation than unsecured loans, both at closing and once the loan is paid off. For borrowers, asset-based lending can be a high-risk gamble that puts their business operations at risk.

• Do SBA loans require collateral?

  Generally, the larger the SBA loan, the more likely it will require collateral. The SBA only requires that standard 7(a) loans, for example, get backed by collateral if the loan amount exceeds $25,000. But the lenders — not the SBA — make the final decision on when to ask for collateral. They may demand collateral in business loans even when the SBA doesn’t require it.