Credit score and collateral fit together almost like peas and carrots. If the first question a lender asks to qualify you for a loan is about your credit score, one of the next questions will be regarding collateral. A poor credit score and no collateral are pretty much the kiss of death to a small business loan in your future, but just because you don’t have traditional collateral, like real estate or heavy equipment, it doesn’t mean you don’t have collateral.
Why Collateral Matters to a Lender
I once heard a small business owner lament that traditional lenders only like to lend your own money back to you. Although I don’t think this is an entirely accurate representation of how lenders look at collateral, as the risk-averse creatures they are, when you have skin in the game most lenders feel like it reduces their risk. When your own assets are on the chopping block, the perception is that you will be less likely to throw in the towel and walk away if things get bad. Although collateral seldom removes all the risk for a lender, it does allow them to mitigate some of their loss should you default on a loan.
The elephant in the room is really this: lenders are in the business to make a profit. Small business lenders are not in the business because they want to give their assets away, there’s no altruistic desire to see small businesses succeed, they want to see you succeed because it means you’ll be able to repay your loan and they’ll be able to make profit. With that in mind, the idea of the need for collateral should make sense.
What If I Don’t Have Real Estate or Something Similar for Collateral?
Not all lenders are looking for that type of collateral. In reality, when a factor advances small business capital based upon your accounts receivable, those accounts receivable are acting as collateral. The same is true regarding a Merchant Cash Advance (MCA)—the monthly recurring credit card transactions act as collateral for the advance. In the case of a factor or an MCA lender, they are actually more interested in your collateral than your credit score.
Of course there is a credit score threshold they won’t go below, a factor or MCA lender will often overlook a less-than-perfect credit score if your accounts receivables or your monthly recurring credit card transactions look good. In the case of a factor, they are more interested in the credit history of your customers and the MCA lender is more interested in the repeatable volume of monthly credit card transactions.
We’ve talked in the past regarding how important it is to protect your credit score. It’s also important to protect anything you might likely need as collateral for a small business loan in the future. That includes any real estate you might own, equipment, and those unique forms of collateral like your AR or merchant accounts.
Click here to read more about what to do if the bank says NO.
Click here to read about some strategies for preparing for a loan.
Click here to read more about options like AR factoring or MCA loans.
Click here to read more about strategies to deal with a poor credit rating.
Click here to learn more about repairing your credit.
Click here to learn about funding an idea-stage business
Click here to learn more about loans from friends and family.