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How much collateral is needed for a small business loan?
An asset can help get you lower rates and faster financing — but your options can be limiting.
A lender may ask that you back your loan with an asset — equipment, real estate or something else in your business’s name that has cash value. You may have an asset in mind you’d like to use, but you’ll want to be sure it’s enough to secure your loan.
How much collateral do I need for a business loan?
Most lenders want collateral that’s worth at least as much as the loan you hope to secure. So if you’re looking to borrow $50,000 for your business, the assets to secure it must have a cash value of at least $50,000.
But often, a lender will only offer you a percentage of your asset’s value to cover depreciation. In these cases, you may only be able to borrow 80% to 90% of your asset’s value — limiting your total loan amount.
Why do business lenders want businesses to put up collateral?
Business lenders want collateral because it minimizes their risk in taking you on as a borrower. The underwriting process helps lenders decide which businesses to lend to. But it doesn’t always offer enough security for the lender.
If you don’t have strong enough credit or can’t meet all the lender’s requirements, you may be required to provide collateral to make up for it. But even businesses that appear strong on paper can still end up defaulting on a loan. Offering secured business loans that require collateral is one of the ways lenders protect themselves against potential losses.
7 types of business collateral
Lenders will accept a wide variety of assets as collateral, but some are more common than others. If you’re looking for a secured business loan, these are most likely to be used as collateral:
1. Real estate
Most lenders are happy to accept both commercial and personal property as collateral because the value of real estate often stays the same or increases over time. These loans typically use the equity in your home or commercial property.
However, using personal property as collateral can become complicated if your business goes under: A lender may seize it if you default on the loan. So while using real estate can be a simple way to secure a loan — especially if you’re just getting started — it’s important to understand the full risk involved before borrowing.
When you finance equipment, it acts as the collateral to back your loan — similar to a car loan. Typically, equipment financing is available for machinery, vehicles and other tools necessary to run your business.
In addition, some lenders may allow you or your business to use equipment to back a general loan. This isn’t as common, and like any secured loan, you risk losing your equipment and other property if you default.
The inventory you purchase can be used to secure a loan. It typically works one of two ways. Either your supplier will offer financing itself or you can contact an outside lender to request a secured loan for inventory costs. Your lender may have an auditor to appraise the value of your inventory before accepting it as collateral.
4. Unpaid invoices and credit card sales
If you receive a large volume of invoices or sales through credit cards, your business may be able to use these as collateral to increase cash flow. These typically take the form of a short-term loan.
Both have significantly less risk than other types of loans. But this means your business may receive a higher interest rate than other types of secured loans — and be stuck with daily or weekly repayments.
A cash-secured loan, typically a term loan or line of credit, includes liquid assets like your business savings account. The total amount your business is eligible for will be based on the amount in your savings accounts. The more your business has access to, the larger your loan can be.
And because your lender won’t have to sell anything to recoup its losses, your business is placed in a lower-risk bracket. This translates to lower rates than other secured loans.
6. Blanket lien
Blanket liens cover a wide variety of assets. They give your lender the right to seize any property, collateral or savings accounts owned by your business. This puts both you and your business at a significant disadvantage if you’re unable to repay your loan, and it could result in losing all your assets to pay an outstanding balance.
But even if you never default, it can still be a difficult loan to handle. Because your assets are tied up in a blanket lien with one lender, your business may not qualify for other secured loans.
7. Personal assets
For newer businesses that might not qualify for other financing, personal assets can be used. Home equity loans, HELOCs and secured personal loans may all be used to fund your business.
However, there is a significant amount of risk when you use a personal asset to secure a loan for your business. If you fail to make payments, default or your business goes under, you’ll be stuck with the bill. And because you used a personal asset as security, the lender will be able to seize it to pay back your loan — which could result in losing your home or other valuables.
What types of collateral don’t lenders accept?
Generally, if your asset loses significant value over time or is difficult sell, lenders won’t accept it as collateral. For instance, you typically can’t secure your loan with computers or software, because of how quickly electronics can depreciate. That being said, a lender may be willing to work with your business and appraise your collateral before rejecting or accepting a loan application.
How do I know how much my collateral is worth?
Lenders often use a loan-to-value ratio to determine how much your proposed collateral is worth. To secure a business loan of $50,000, knowing how your assets are valued by your lender can help you select appropriate collateral.
The type of asset you offer as collateral also affects how much you’re expected to offer up. Lenders value your collateral depending on what its type:
- Real estate. Lenders typically accept up to 75% of a commercial real estate property’s value as collateral.
- Equipment financing. The equipment itself can serve as collateral, but the the loan-to-value ratio for equipment is often 50% to 60%.
- Accounts receivables. Invoice financing requires you to offer your business’s unpaid invoices to secure your loan. The more creditworthy your customers, the better, with lenders typically offering a loan-to-value ratio of 80% to 90%.
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Don’t have enough collateral? Here’s what to do next
If you’re turned down by a lender due to insufficient collateral, don’t fret. You can better position your business to secure the funding it needs with action:
- Look for liquid assets. Take another look at your business and personal assets to see if there’s something you overlooked. Lenders are more likely to accept liquid assets like invoices or accounts receivable that can be converted into cash quickly.
- Opt for an unsecured loan. While interest rates on secured business loans are often more competitive, you might find funding through an unsecured business loan if your business has an established credit history.
- Try crowdfunding. If you’re a startup looking for capital, you may be able to get the funds you need with crowdfunding through platforms like Kickstarter, GoFundMe or Indiegogo.
- Take out a personal loan. If you’re unable to secure a business loan, a personal loan for business could be an option. Before you apply, carefully read the loan’s restrictions to make sure you can use your funds for business needs.
I backed my loan with collateral. So why was my application rejected?
Backing your loan with collateral doesn’t guarantee approval. A lender can reject your business loan application for any number of reasons that include:
- Inconsistent cash flow. The steadier your revenue stream, the better. But for small businesses, maintaining consistent cash flow can be a challenge. Stay on top of overdue invoices and use accounting software to keep your records in order.
- Debt load. If you carry debt with other lenders, a potential provider could see it as a red flag. Consolidating your debt may help, but you might need to pay down your existing loans before looking for more funding.
- Not enough time in business. If you’re a startup, you likely lack the assets and cash flow most lenders want to see on a funding application. Luckily, many business lenders specialize in lending to new businesses, giving you options.
Lenders typically want collateral that’s worth at least as much as you plan to borrow. But other factors can affect the amount of collateral you need for a loan, including your business’s age, credit history and financial strength.
Compare your lending options to find the best loan your business is eligible for.
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