Discover How Much Collateral Is Needed for a Business Loan
Business owners approaching secured commercial lending for the first time are often unsure how much collateral is needed for a business loan. Lenders like collateral because they can take possession of valuable assets if their borrower defaults. They can then sell those assets to try to clear any outstanding balance that’s owed.
Coming up, we’ll go over everything you need to know about business loan collateral, including how much is needed. We’ll also explain what assets lenders accept as collateral, how they value them, and how collateral works for different types of financing. We’ll then share tips on which assets to offer as collateral so you don’t put your business at risk.
How Much Collateral Is Needed for a Business Loan?
How much collateral is needed for a business loan will vary depending on your lender and the type of loan you’re applying for. The amount you need to provide will depend on your lender’s loan-to-value (LTV) ratio.
Let’s take a closer look at how this works.
When you send in your loan application, your lender will hire a professional appraiser to determine the value of the assets that you provide as collateral.
However, it’s important to know that lenders won’t generally offer you a loan for the total appraised value of your assets. That’s because, if they’re forced to sell the assets to cover any outstanding balance on a loan you default on, they may not get full price. This could be due to the fact that it’s a forced sale or market conditions may be volatile.
Lenders apply an LTV ratio to their finance packages. So, if you offered an asset for collateral that an appraiser valued at $100,000, and the lender had an LTV of 80%, then all other factors being equal, they’d lend you no more than $80,000 against it.
When comparing lenders, the general rule of thumb is to look for an LTV of 80% or less.
What Types of Collateral Do Business Lenders Accept?
You can offer both personal and business assets as collateral on secured commercial loans.
Lenders may accept one or more of the following as business loan collateral:
Accounts receivables: These are outstanding invoices you’ve sent out to customers that have not been paid yet.
Real estate: Lenders will generally accept both residential and commercial real estate from small business owners as collateral.
Inventory: You can offer any unsold items or goods as collateral. This is particularly useful for product-based businesses like retail stores or e-commerce shops.
Business equipment: This is the machinery, vehicles, and other items you need to run your business. An example might be a pizza oven for a restaurant.
Blanket liens: Sometimes called UCC liens, blanket liens give lenders the right to seize all of your business assets if you default. That means your business could lose everything if you can’t pay back your loan.
Cash: This can be cash you have in your business bank account, personal bank account, or a letter of credit from a traditional bank.
Marketable securities: This can include investments like stocks or bonds that can be sold to repay lenders.
Personal assets: You can pledge personal assets like your primary residential property, any real estate you own personally that you rent out, your investments, or savings.
Rare or customized assets: This can include rare and collectible assets like fine art, high-end jewelry, or luxury watches.
Future cash flows: Certain types of merchant funding products, like merchant cash advances and revenue-based financing let you pledge your business’s future revenues.
Intellectual property: Most commonly offered by startups and disruptors in the tech and science sectors, this type of collateral includes your patents, trademarks, or copyrights.
Personal guarantee: If you sign a personal guarantee and your business defaults on the loan, the lender can seize your personal assets to sell so they can recover any outstanding balance owed.
What Types of Business Loans May Require Collateral?
Some types of business financing commonly include collateral, such as a commercial real estate loan, and other types may be available with both secured (requires collateral) and unsecured (doesn’t require collateral) options.
Business loan types will also differ in how collateral is provided. There are three options:
You may provide collateral in the form of cash or assets you own.
The collateral for a loan may be whatever it is you’re purchasing with the loan, such as real estate or equipment.
Your future income will serve as the collateral.
Loans Where You Provide the Collateral
Below are some common types of secured loans where you provide the collateral.
Secured Small Business Loan
A secured small business loan is simply a general loan that requires collateral. These loans are less risky for a lender.
For this reason, many startup business loans are secured loans because the company applying for the funds may be unable to meet the standard loan requirements of an unsecured facility. This could be because of a lack of credit history or not being in business long enough. A company may also seek a secured business loan to obtain a lower interest rate.
Secured Business Lines of Credit
Business lines of credit work like credit cards. You have a maximum amount of money that you can borrow at any one time — your credit limit. You will only owe interest on and repay the amount you actually withdraw. Every time you make a repayment that money becomes available for you to borrow again.
A secured business line of credit requires collateral. But it’s also possible to take out an unsecured version that doesn’t need collateral. For example, with Backd’s business line of credit, you can receive between $10,000 and $750,000 within 24 hours, collateral-free.
Bridge Loans
Bridge loans provide funding to tide you over during a cash shortfall until a future event takes place, like the settling of a large invoice by a customer. They are highly customized, and lenders will consider a wide range of assets for collateral.
While traditional bridge loans require collateral, you can use other flexible financing options for bridge funding. For example, Backd’s working capital advance doesn’t require collateral and offers a 24-hour turnaround time. You can apply for between $10,000 and $2 million worth of funding — meaning you can get the capital you need during cash flow gaps to continue to meet payroll and rent, invest in inventory, and more.
SBA 7(a) Loans
Each SBA 7a loan type has different collateral requirements. In most cases, a lender is required to take collateral on loans over $50,000. The Small Business Administration (SBA) generally allows the lender to apply their existing collateral policy to these loans, as long as they don’t decline an application only because of inadequate collateral.
However, in the case of Standard 7(a) loans where the borrowed funds are being used to acquire, improve, or refinance assets, such as equipment, those assets can serve as the collateral. Similarly, 7(a) Export Working Capital loans will use the inventory produced and account receivables generated from the export activity as the collateral.
Loans Where the Asset You Purchase Is the Collateral
Below are two types of secured loans where the assets you’re acquiring with the loan doubles as your collateral.
Commercial Mortgages
Commercial mortgages (or commercial real estate loans) are the preferred loan option for companies looking to purchase retail units, industrial units, and office buildings. The property itself serves as the collateral, and the LTV on commercial mortgages is generally between 65%-80%.
SBA 504 Loans
With an SBA 504 loan, the assets you’re purchasing with the loan are the collateral. For example, if you’re using the loan to acquire new machinery or equipment, that machinery and equipment will serve as your collateral. This means you won’t need to pledge other cash or assets to secure the loan.
Equipment Financing
Companies use equipment loans to spread out the cost of new machinery, vehicles, or other essential business equipment without tying up their working capital. The equipment also acts as collateral on your loan. Therefore, you don’t need to provide liens on property, accounts receivables, and so on.
Loans Using Future Revenues as Collateral
Following are the two main types of loans that use your future revenues as collateral.
Merchant Cash Advances/Revenue-Based Finance
Merchant cash advances are short-term financing options where a lender provides a lump sum payment in exchange for a portion of future credit card sales.
Revenue-based finance differs in that it takes a percentage of overall revenue, not just credit card sales, and often has more flexible repayment terms.
The collateral you offer on both forms of funding is your future revenue streams.
Invoice Factoring
With invoice financing (also called invoice factoring), your collateral is the value in the outstanding invoices customers have not settled yet.
When you issue an invoice, you forward it to the factorer, who pays you up to 95% of the invoice value. They pay you the remainder of the invoice minus their fee when your client settles their bill.
Invoice factoring is different from the other forms of business loan types in that lenders are more interested in the creditworthiness of your customers and not your particular business.
Why Choose a Secured Business Loan Over an Unsecured Business Loan?
Business owners choose secured loans over unsecured loans for the following reasons:
Loan amounts: The amount of money you can borrow with a secured business loan is higher, meaning you can fund more ambitious projects.
Credit history: Startups and newer businesses rarely have the credit history and financial track record that lenders look for. Securing loans on assets can help overcome this objection and increase approval chances.
Longer-term loans: To reduce risk, lenders require unsecured loans to be paid back over a shorter time period. Longer-term loans secured on collateral reduce the level of monthly repayments, making them more manageable for businesses.
Lower interest rates: Borrowers taking out unsecured loans often pay higher interest rates to reflect the greater risk to lenders.
Bad credit: Lenders are more willing to work with borrowers with poor business credit scores or personal credit scores when the loan is secured. You have a better chance of getting access to the cash your business needs by offering collateral.
How to Meet Lender Collateral Requirements Without Compromising the Running of Your Business
Offering assets to meet lender collateral requirements might reduce their risk of loss, but it certainly increases yours.
To protect your interests, first make a list of all your business assets. Identify which assets, if lost, would most disrupt your business operations and offer them first to lenders.
That could be property that’s not in regular use by your business or older machinery that’s less critical to production and manufacturing.
Businesses with strong cash flows have much less to lose by using invoice factoring. At worst, the money you’re advanced by a customer who later refused to pay will be clawed back from you. The loss of working capital in this situation is far preferable to the loss of an unproductive but valuable asset you could later secure further funding against.
Choose the Right Financing Option for Your Business
When working out how much collateral is needed for a business loan, you have to factor in that lenders will assign a lower value to your assets than the market. Your company may have a substantial asset profile, but that doesn't mean you can borrow against the full worth of everything it owns.
Secured lending also offers you access to more capital, lower interest rates, and longer repayment terms. However, the trade-off is that if your business does not perform as required, you risk permanently losing those assets for good with most forms of collateral-backed finance.
Secured lending, although useful, isn’t for everyone, especially if you don’t have any assets to pledge as collateral or you don’t want to. Fortunately, there are online lenders — like Backd ‚ that don’t require collateral and help companies of all sizes and in various industries access the financing they need.
With Backd, you can choose one of these two commercial financial options:
Business line of credit: Access up to $750,000 and draw down funds when you need them.
Working capital advance: Borrow up to $2 million to easily bridge cash flow gaps.
Apply now and be funded as soon as tomorrow.
