When It Comes to Small Business Loans, Collateral Counts
By Taylor Sisk, Staples® Contributing Writer
In the perfect world, a bank would loan your business money based solely on your good looks and debonair manner.
But while waiting for that idealized world to materialize, give some thought to what you have in the way of collateral that will convince a lender you’re a good risk.
Real estate, equipment, inventory and accounts receivable are all potential sources of collateral. So is your home.
But “not all collateral is created equal," notes Rob Diestel, who heads Staples’ payment strategy and financial services. “And it’s not something you should take lightly.”
“Make sure to talk to your attorney and your accountant before choosing what to offer as collateral, and whether or not you even should. It’s the best way to ensure that the guarantee builds your business, rather than busts it.”
Unfortunately, whether you should offer collateral may not be your decision to make.
Wes Pope, senior vice president and commercial banking officer at Durham, NC–based First South Bank, says his bank requires collateral “the vast majority of the time.”
Unsecured credit, Pope says, is typically only offered for “short-term loans to very high-net-worth borrowers.”
Aim for generous terms
Collateralized business loans typically carry lower interest rates and down payment requirements than non-collateralized ones.
“The repayment terms are not as generous or as long as they might be for unsecured loans,” Pope explains. “Generally, for unsecured loans you want to be paid back in no longer than two or three years. With secured loans, depending on the collateral, you might amortize it for five or seven years — or if it’s real estate, 20 years.
The type of collateral the lender requests is often dependent on the purpose and duration of the loan. You might be able to secure funds with advance orders, using verified product orders as collateral. Emphasis on “might,” however.
“We typically don’t do long-term loans secured by accounts receivable,” Pope says. “If they need a long-term loan to finance growth, we’d want collateral that has some sort of correlation with the terms of the loan. Receivables come and go, inventory comes and goes.
“If we’re looking at lines of credit or a loan of just a couple of years, we might accept receivables or inventory,” he continues. “But for a longer-term loan, we look for collateral that has lasting value. For a small business, it might be a second mortgage on the owner’s house.”
According to the U.S. Small Business Administration, asset-based lenders advance funds based on an agreed percentage of the assets’ value, which is generally 70 to 80 percent of eligible receivables and 50 percent of finished inventory.
Of course, that collateral must be marketable.
“You take collateral as a last-ditch payment source,” Pope says. “So if you’re taking it, you want to know that you can get something for it. We’d be looking for things that we can sell ourselves if we have to.
“If the borrower is manufacturing something, raw materials and finished goods have value but something partially completed may not.”
In some cases in which there doesn’t appear to be sufficient collateral available, the SBA requires the lender to get “keyman” life insurance.
“In case of the death of one of the key operators of the business, the loan may not be paid back as agreed, as nobody knows how to run the business efficiently,” explains Aga Merx, SBA department manager of Bank of American Fork in Utah, “so the lender will receive the life insurance proceeds to pay the loan down.”
Choose bankers carefully
As for who to ask for money, it’s always best to turn to someone with whom you’ve done business in the past. But if that’s not possible, the Federal Trade Commission suggests staying away from anyone who:
- Pressures you into applying for a loan for more money than you need
- Pressures you into accepting monthly payments you can't comfortably make
- Doesn’t provide required loan disclosures or tells you not to read them
- Promises one set of terms when you apply but gives you another to sign
- Asks you to sign blank forms, saying they'll fill in the blanks later
- Says you can't have copies of the documents you signed
If you don’t like the collateral terms, you do have other options. Mike Glanz, CEO of HireAHelper in Oceanside, CA, needed a cash infusion but didn't want to co-sign the loan on behalf of the business or put up collateral.
“Banks routinely turned us down for $100,000 lines of credit when we had millions in revenue and were profitable,” Glanz recalls. He finally went with a lender offering money that wasn't collateralized but was at high interest. “They were a good option for cash fast, and the money let us expand rapidly.”
The bottom line, says Blair Koch, CEO of The Alternative Board-Denver West, is to shop around till you find someone you trust with your business.
“There are lots of bankers around,” she notes. “There are far fewer trusted advisors who will be there for you and your business. Find out what role your banker has in the decision process.”
DISCLAIMER: This information is not intended as a substitute for professional legal, financial, tax or accounting consultation; we provide it “as is” without any representations or warranties, express or implied. There are strict state and federal laws and regulations pertaining to raising and utilizing funding. Always consult financial, legal and accounting professionals when you have specific questions about any business matter of this kind.