When you take out any type of small business loan, you’re putting your business’s reputation, profits, and credit score on the line.
With a secured loan, the collateral that you submit is also at risk. However, unlike your reputation, profits, and credit history, you have choices when it comes to choosing the type of collateral you’re willing to risk.
The reason that you’ll have options is because there are several types of business collateral that can be used to secure a loan. Of course, as with any financing-related decision you make, there are benefits and drawbacks related to the collateral you choose.
In this blog post, we’ll review four types of collateral you could use to secure a loan. In addition, we’ll explore how your choice of collateral will affect your business’s plans.
As you may know, using a home as collateral for a small business loan is a viable option for many entrepreneurs. For business lenders, real estate is an attractive way to secure a loan because it holds its value well. Entrepreneurs may also benefit because real estate is generally worth at least a couple of millions, which gives owners a chance to secure larger loan amounts and better loan terms.
However, while real estate may be a convenient choice, it’s also a risky one. For example, if you put up your primary residence as collateral and default on your loan, you’ll lose your home. Of course, you could also use other real estate you use to run your business, but that’s a risky move as well, especially if you rely on that property for income. Ultimately, risk is relative; if you own real estate that’s less critical to your life or business, it may be worth using if your lender requires collateral to get approved.
Equipment can be used as collateral to secure a loan, but it depends on a few notable factors.
First, you’ll need to consider the value of the equipment, not just the price. For example, heavy machinery may technically be valuable, but if it’s difficult to find a buyer, it won’t be viewed as valuable to the lender.
Similarly, computers or other hardware tend to become obsolete fairly quickly, so their value depreciates over time. Still, if the loan amount is relatively low, equipment may be a great option to use as collateral. As the borrower, though, you should contemplate the consequences of losing that equipment to decide whether it’s worth the risk.
Also, if you take out an equipment loan, the machinery that you purchase with the loan proceeds will be used as collateral. If you fail to repay the loan, the machinery will be seized.
One of the most common forms of collateral that business lenders will accept is inventory. In fact, from a lender’s perspective, many of the considerations for equipment, such as liquidation value and future depreciation, apply to inventory as well. As a result, the amount and cost of your loan may vary by lender and how they value your inventory.
Again, by putting up inventory as collateral, you’ll risk losing it if you default on your loan agreement. As you can imagine, this can create a difficult scenario, especially if you have other debts.
In the event that you can’t repay the loan, your inventory will be taken, and you may struggle to:
Waiting for monthly payments on outstanding invoices can cause major cash flow challenges for small business owners. However, you can put those invoices to work by using them as collateral for a business loan.
If you choose to use invoices as collateral, you’ll receive cash from your lender and when it comes time, they’ll collect on the outstanding invoices. This is also known as invoice financing.
In this type of agreement, you’ll receive cash up front and won’t have to worry about waiting for the cash from your invoices to come in. However, you’ll have to pay fees or other costs to the lender, which means your business will earn less money than it would have if you collected the invoices yourself.
Finally, because the loan amount will be capped somewhere below the total value of your invoices, there will be a ceiling on how much you can borrow.