3 Types Of Collateral For Business Loans

6 min read By Cloey Mangali on August 14, 2018

To launch your dream business, it might be necessary to take out a business loan. But one very important question you may be asking before you begin the application is: What can be used as collateral to secure a loan?

Do you need a collateral for your business loan to-be? How much collateral will you need to establish for a business loan? What can be used for collateral to secure a loan? These questions and more are faced by every budding entrepreneur.

Even the best business concept cannot and will not succeed without adequate capital. Sufficient money must be put into business for it to grow and succeed.

There are different types of collateral that can be used to support your ambition to establish your own business.

1. Asset-based collateral

This type of collateral is what lenders refer to as a fixed asset. These types of assets are often your best choice when applying for a business loan.

Remember, however, in case the business doesn’t go as expected, lenders can seize will seize these assets as payment.

There are four types of asset-based collaterals:

• Inventory financing

This means that the assets you present as collateral are the items that are listed in your business inventory. If you can’t pay back your loan, your lender has all the rights to take over your businesses’ inventory as a payment for your debt.

It may sound simple but, going for this as your collateral isn’t always the best choice. Lenders usually view this as an unsecured lending. There are times when borrowers are having a hard time selling their inventory at their expected price thus they will be forced to sell it at a lower price, giving the lender a bigger loss. For this reason, many lenders find it difficult to approve loans that are using their inventories as a collateral.

• Real estate property

One of the most common types of collateral accepted by lenders when applying for a loan is real estate.

Real estate assets, such as your own house, are often used as collateral because they are readily available.

But before using it as a collateral, keep in mind the risk at hand. If you will not be able to pay the loan that you have incurred, it will be a huge burden on you and your finances.

Aside from houses, there are also other properties which can be used as collateral such as boats, cars, equipment, motorcycles, and the like.

• Invoice financing

With invoice financing lenders allow you to make use of your accounts receivable or your outstanding invoices as your collateral. You will give the lenders a share of the money that is owed to you once it is paid.

With this type of financing, your eligibility to borrow will depend on the amount of money that is coming your way. No more and no less.

• Equipment financing

Similar to inventory financing, equipment financing also allows you to make use of the different equipment used in your business as collateral. It can be your computers, copy machines, printer, and the like. Nonetheless, just like inventory financing, you will probably have a hard time looking for lenders who will approve your loan application at once.

(Read: How Much Should You Borrow To Grow Your Business? Here Are 4 Points To Consider)

2. Personal guarantees

If in case you don’t have any fixed asset available to be used as a collateral, or your fixed assets don’t meet the value required to you by your lender, you might be obliged to present a personal guarantee.

There are two different types of personal guarantees that you can use as collateral on your loan: (1) Unlimited Personal Guarantee, and (2) Limited Personal Guarantee. There is a huge difference between the two that is why you need to fully understand them before you decide on using any on your loan.

• Limited Personal Guarantee

When you choose a limited personal guarantee as your type of collateral, you will be sharing the burden of paying your loan with a shareholder having a 20% or greater contribution in your company.

A limited personal guarantee can be further broken down into two different types:

1. Several Guarantee

With this type of personal guarantee, each shareholder should know what they owe if in case the business was shut down.

Whatever percentage of each shareholder is responsible for paying, it will still be correlated with the investment of the whole company.

2. Joint and Several Guarantee

With this type of personal guarantee, each shareholder who signed to the agreement holds 100 percent of the responsibility of paying the full amount of debt owed to the lender.

If in case one of the shareholders who signed in the agreement is lacking enough assets to pay for their part, the lender has all the rights to make you pay for the remaining debt.

•  Unlimited Personal Guarantees

With an unlimited Personal Guarantee, you are the only one accountable for paying the full amount of your loan. With this, you are giving your lender the right to take over all your assets in case of payment failure to cover up the balance of your loan.

You should also keep in mind that with an unlimited personal guarantee, the assets that can be seized by the lender are not limited to the business collateral. If you fail to pay your acquired loan, your car, house, retirement fund or even your savings for your child’s education can be seized. In addition, if you are married, it can also affect the assets of your spouse.

3. Liens

Some lenders, instead of requiring a collateral, file a lien on the applicant’s business as a guarantee of payment.

When a lender files a lien, the lender has all the legal rights to take over all the assets of the company of the applicant if he/she will be unable to repay the loan. These assets can be in means of accounts receivables, company equipment, or real estate. Multiple loans mean multiple liens.

When it comes to loans with multiple liens, the lender who is first to put the lien has all the rights to collect his/her part on the collateral. Once his/her lien has been removed, the process goes on to the next lender on the list and so on.

It just means that the lower the lender’s rank on the lien is, the higher the chances that he/she will be losing money. If this happens, if a lender notices that you have a loan with multiple liens, you are less likely to be approved for a loan.

(Read: How To Get Approved For A Business Loan)

There are two types of liens:

• UCC Lien

If you currently have a loan and decided that you want to pull it all out, a Uniform Commercial Code (UCC) Lien is usually incorporated in case of default. It can be placed on your business even without your knowledge because this is the way of the lender to secure assurance from you.

• Blanket Lien

A blanket lien put on your business gives the lender the rights to all forms of collateral in case you will not be able to repay your debt. This type of lien gives the lender a protection advantage in case a default happens.

That is why before signing to a loan that may look appealing to you, double check everything to also protect yourself and your business if in case everything is falling out of place.

Just a piece of advice to all, always make sure to read between the lines of your loan agreement before signing it. If your lender doesn’t require you any physical collateral or guarantee, liens can always be used to take your businesses or properties as collateral.

Always keep in mind that applying for a loan will expose both you and the lender to certain risks. So, it is important to double check your capability of paying the loan that you are planning to apply rather than risk losing everything in cases of faulty circumstances.

Sources:

https://www.fundera.com/blog/5-types-of-collateral

https://www.shopkeep.com/blog/collateral-to-use-small-business-loans