Many traditional lenders like banks, credit unions, and the Small Business Administration (SBA) all require collateral to secure a small business loan. Unfortunately, this makes if difficult for an otherwise healthy and profitable business to qualify for a loan because they lack what a traditional lender would consider appropriate collateral.
With that in mind, it's important to understand what collateral is, how lenders evaluate and value your collateral, and what some lenders use instead of specific collateral to secure a loan.
Traditionally, specific collateral to secure a small business loan has been a requirement for most traditional small business lenders. Traditional lenders, like banks, typically look for secure assets like real estate or equipment as collateral; although anything of value the lender can sell to satisfy your debt should you default might be accepted—depending on the lender.
Traditional lenders (who frequently require specific collateral) may use the collateral to determine how much they will lend to a business. The value of the collateral is used to determine what’s referred to as the loan-to-value ratio based upon the nature of the collateral. In other words, your banker may allow you to borrow against 75 percent of the value of appraised real estate or 60 to 80 percent of the value of what they call ready-to-go inventory. Because individual lenders might consider their loan-to-value ratios differently, you’ll need to ask any potential lender how they intend to set that value.
The SBA requires collateral as security on most SBA loans (when worthwhile assets are available). When describing the collateral requirements for a 7(a) loan, according to the SBA, “The SBA will generally not decline a loan when inadequacy of collateral is the only unfavorable factor.” In other words, if the rest of your application looks good, but you don’t have adequate collateral, your application for a 7(a) loan won’t immediately be rejected because you don’t have sufficient collateral—but they will likely want to secure the loan with all the collateral you do have available.
The SBA’s definition, which is pretty straightforward and is a good guide for other traditional financing, goes like this:
"Assets such as equipment, buildings, accounts receivable, and (in some cases) inventory are considered possible sources of repayment if they can be sold by the bank for cash. Collateral can consist of assets that are usable in the business as well as personal assets that remain outside the business.
You can assume that all assets financed with borrowed funds will be used as collateral for the loan. Depending on how much equity was contributed by you toward the acquisition of these assets, the lender may require other business assets as collateral.
“Certified appraisals are required for loans greater than $250,000 secured by commercial real estate. The SBA may require professional appraisals of both business and personal assets, plus any necessary survey and/or feasibility study. When real estate is being used as collateral, banks and other regulated lenders are required by law to obtain third-party valuation on transactions of $50,000 or more."
Once your proposed collateral has been accepted, the banker will determine the loan-to-value ratio based upon the nature of the asset.
Most traditional lenders require collateral with a small business loan, but there are other lenders that do not require a specific type or value of a particular asset to approve a loan, but do secure the loan with a general-lien on your business assets.
A General Lien on Business Assets or Collateral vs. Specific Collateral
Some lenders, including many online lenders, don’t require specific collateral, but rather require a general lien on your business assets (without valuing those business assets) and a personal guarantee to secure the loan. While these loans are collateralized, the general-lien approach may make qualifying for a loan easier and/or faster, depending upon the nature of your business and your business assets.
What’s more, because the loan is not based upon the loan-to-value ratio of any specific collateral, the lender is using other data points to evaluate a business owner’s creditworthiness. For example, by looking at the overall health of your business, your cash flow, and your personal and business credit profile, you might even qualify for more than you would with a traditionally collateralized loan.
By looking at the loan process differently, many lenders, like OnDeck, are making more capital available to small businesses that don’t have the required assets needed to collateralize a loan at the local bank. Meaning, a lack of sufficient business collateral doesn’t necessarily mean you can’t get a small business loan.
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