Dec 22, 2019

Making Your Business Loan Secured or Unsecured

Starting a business brings with it a host of new decisions. Should you structure it as a sole proprietorship, partnership, corporation, S corporation, or a Limited Liability Company (LLC)? Will you operate exclusively online, or would it be better to also have a brick-and-mortar location?

If you use debt financing as a way to fund your business, you’ll also need to consider what type of loan to pursue. There are diverse options, including business lines of credit, short term loans, business term loans, equipment financing, business acquisition loans, SBA loans, and startup loans.

In addition to considering the various loan products, you’ll also need to decide whether to make the business loan secured or unsecured. What is a secured business loan and what’s an unsecured loan? It all comes down to collateral. A secured business loan is backed up by something of value, while an unsecured loan leaves the lender more exposed. Both options have their strengths and weaknesses, so this article will help you evaluate which approach is best for your business.

The Nuts and Bolts of Secured Business Loans

Entrepreneurs have more skin in the game with a secured business loan, meaning they offer up a personal asset to cover the cost of the loan if they’re unable to make their payments. Common examples of collateral include homes, cars, stocks, bonds, real estate, inventory, or equipment.

The value of the collateral needs to match at least the value of the loan. In some cases, lenders will ask for the collateral to exceed the loan amount because some forms of collateral, such as real estate, take substantial time and effort to convert into cash.

For example, if you used a 5-acre lot as collateral and then defaulted on the loan, the lender wouldn’t simply keep the property as a memento. They’d try to sell the lot, which would require them to jump through various hoops. Upon the sale of the property, the lender would take enough money to cover the amount you owe and then give you the remainder.

It’s important to obtain an accurate estimate for the asset’s value before talking with your lender. They will be inclined to undervalue it because they prefer to liquidate assets in a hurry, which is done at lower-than-usual prices. If you’re prepared with a recent estimate, you’ll be better able to negotiate with them.

As you might expect, lenders are more generous when their risk is lowered. For starters, the qualification standards for a secured loan are more lenient than with an unsecured loan. So if your business is new or you have less-than-stellar credit, this option is your best bet.

Secured loans have higher dollar amounts than unsecured loans, making them ideal for larger projects and initiatives, such as buying equipment or financing purchase orders. The repayment terms and interest rates can also be more favorable to borrowers, meaning you’ll have more time to repay the loan. And the lower monthly payments will help to increase your cash on hand for inventory, staffing, and other expenses related to running your business.

What is a secured business loan’s main drawback? The fact that you’re personally liable for the money you’ve borrowed. If something were to go wrong, your collateral would belong to the lender. For this reason, it’s essential that you only seek loans you can confidently repay—and only offer up collateral that you could tolerate losing if things were to go south.

The Nuts and Bolts of Unsecured Business Loans

No collateral is involved with an unsecured business loan, meaning the lender faces higher risk. Because of this scenario, the lender will go over your credit score with a fine-tooth comb. They’ll also pay close attention to the financial history of your company, meaning new businesses seldom qualify. If you don’t have a robust credit history, balance sheets, cash flow, and cash reserves, lenders simply won’t have enough data to make an educated decision.

For businesses with a track record of 2 or more years and annual earnings that reach at least 6 figures, an unsecured business loan can be an excellent choice. Because no collateral is required, you won’t need to put your personal assets on the chopping block. The absence of collateral also simplifies and accelerates the application process, as there won’t be analysis and dialogue involving the collateral to be used.

The dollar amounts for unsecured loans usually max out at $50,000, so this type of financing is best suited for smaller expenses. As you forecast your finances, remember that you’ll also need to account for the higher interest rates and shorter repayment terms typical of unsecured loans.

If you meet the lender’s qualifications and have financing needs in the range of what an unsecured business loan provides, this avenue can be a solid option. It’s a streamlined way to obtain low-risk money for your business.

Making an Informed Decision on Financing

The bottom line is that you have numerous choices when it comes to obtaining a loan for your business. There’s no silver bullet that’s best for all situations, so it’s crucial for you to consider every angle carefully before you begin submitting applications.

In most cases, the strength of your finances and the amount of money you need to borrow will dictate whether you go with a secured or unsecured business loan. From there, you’ll just need to decide which lender and loan product best match your needs.

Start preparing now so you’ll be ready to roll when you find the right loan. Get your business plan dialed in, ensure your credit score is accurate, and assemble the required documents. Any effort you put into getting yourself ready can potentially save you hours of work when it comes time to click submit on your chosen application. Plus, your preparations will foster confidence, which is one of the most crucial elements of any successful loan application.

About the author

Grant Olsen
Grant Olsen
Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.

Comments

  1. Whether you have an unsecured or secured loan the 5 C’s of credit is important to know. The better your odds of getting your loan if you prepare!
    1. Credit– what does your credit report and score look like?
    2. Collateral–do you have any asset i.e. your home equity, savings, etc to pledge?
    3. Conditions in the market–right now the economy is making it tough for the small business. Banks are under tighter regs so money is not flowing easily
    4. Character–sounds hokey, but if you have an address of San Quentin or other major issues with the law, drugs, outstanding liens, etc. you may have problems
    5. Capacity–does the business have the ability to pay on the loan now and in the future.
    Without the above knowledge you are NOT prepared to apply for an unsecured or secured loan. You want to get your best terms for your money so prepare accordingly!
    Denise

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