What Is Business Collateral? – businessnewsdaily.com

• Collateral is any asset a business uses to secure a loan. Secured loans generally have lower interest rates than unsecured loans.
• Most types of business loans require businesses to put up collateral in order to receive funding.
• Collateral can include real estate, equipment, inventory and outstanding invoices.
• This article is for business owners interested in business loans and funding.

Business collateral is property or other assets that a business can use to secure a loan. If the business fails to repay a loan secured by collateral, the lender can seize that collateral and sell it to try to get their money back.

Most business loans require some sort of collateral to qualify. If your business doesn’t have collateral that can be pledged to secure a loan, you will likely pay a higher interest rate or get less favorable terms because the loan represents more risk for the lender.

What is collateral?

Collateral is an asset that a business can use as security for a loan. To be usable as collateral, the asset can’t already be pledged against an outstanding loan or have other claims against it. The business must also actually own and control the asset to be able to pledge it as security for a loan.

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Businesses typically need collateral in order to qualify for certain loan products. Assets that you can pledge for a loan allow you to qualify for better terms and lower interest rates, because the asset provides protection for the lender: If you default on the loan, they can get their money back by selling the collateral.

When most people think of collateral, they think of real estate, which is frequently used as security for business loans. But loans can also be secured by equipment, inventory or company receivables. The more tangible the asset is – the closer it is to cash and the more stable its value – the more security it offers the lender.

Key takeaway: Most business loans require some form of collateral to secure the loan before funding is delivered. This can be real estate, equipment, accounts receivable or some other asset.

How collateral works with business loans

When you apply for a business loan, you need to tell the lender whether you’ll be securing the loan with collateral and, if so, what assets you’ll be using. This property will need to be owned by your business, whether it’s an office, a storefront, a warehouse, or a vehicle or another type of equipment.

If you’re applying for a loan in order to purchase one of these assets, your loan will be secured by the asset you’re purchasing almost by default (unless the lender asks for collateral on top of the asset being purchased).

Then, when you’re executing your loan documents, you’ll be required to sign a lien agreement, effectively giving the lender a claim against the collateral securing the loan. If your business later defaults on the debt, the lender can file to foreclose on the collateral and then sell it to recoup any unpaid loan balance.

If there’s any money left over after the lender sells the collateral, your business will get the rest (though there usually isn’t anything left after the lender recoups legal fees and accrued interest and penalties).

If the collateral is the only thing securing the loan, that’s the lender’s only recourse. But most small business owners also have to personally guarantee loans for their businesses. This means that if the lender doesn’t recoup all their money after seizing and selling your business’s collateral, they can sue you personally for repayment of the remaining balance.

[Considering other financing options? Read our guide on how to get a business loan.]

What qualifies as collateral?

To qualify as good collateral for a business loan, an asset needs to be owned and controlled by your business. It also needs to be in good working order, have a reliable value, and not be subject to any claims from other lenders or other parties.

These are common examples of collateral for business loans:

• Real estate: This is most often an office, store, warehouse or other facility, though it can also include residential property being used for rental properties or for development.
• Inventory: Borrowing against inventory is extremely common for retailers, who then need to provide updated inventory lists to their lender on a periodic basis so the lender can ensure their loan is still properly collateralized. If the retailer has sold down their inventory and not restocked, they may need to pay down their loan.
• Equipment: This can include business vehicles, heavy equipment like cranes, office equipment and even furniture.
• Receivables: A receivable is money a customer owes you for work or a product you already delivered. Receivables that are less than 90 days outstanding are usually sound collateral for lenders, who consider these receivables almost the same as cash.

Generally, you must secure business loans with some type of collateral. Some lenders provide loans with just a personal guarantee as collateral (a signature line of credit, for example), but these loans are very rare and typically reserved for a lender’s preferred customers, who often have high net worth or high incomes.

How much collateral do you need?

The amount of collateral you need to get a loan depends on your credit profile, your business’s industry, your intended use for the loan proceeds and other factors. These factors help a lender judge the overall safety of a loan and the likelihood that you’ll repay it. Generally, though, most lenders won’t loan more than 80% of an asset’s value; this protects them in case the asset’s value declines or they have to seize and sell it in a fire sale.

Since lenders won’t lend more than 80% of the value of collateral, the amount of collateral your business needs depends on how much you want to borrow. Typically, you need to pledge collateral worth at least 25% more than the amount you need to borrow. So if you want to borrow $100, you should plan to secure the loan with at least $125 worth of collateral.

However, if you have bad credit, have defaulted on a loan or filed for bankruptcy, or run a high-risk business, the loan may represent greater risk for the lender and require additional collateral.

Some lenders don’t require collateral. To learn about business loan providers that won’t ask for collateral, check out our review of Fora Financial, our Balboa Capital review, or our review of Rapid Finance.

Key takeaway: The value of collateral depends on the total value of the loan you apply for, as well as your business’s credit profile and your personal credit history.

What types of business financing require collateral?

Almost all business financing requires some form of collateral. The type and amount of collateral required vary by type of financing, your business credit profile, and your business’s industry.

Collateral ratios by financing type

There are very few types of business loans that don’t require some form of collateral. Credit cards are one type that don’t, although collateral may still be required for borrowers with bad credit who need to start with a secured credit card. The only other common type of business loan that doesn’t require collateral is an unsecured line of credit, but these typically charge higher interest rates than other secured options and are often only available to the lender’s preferred customers.