Collateral for a Business Loan: How Much Do You Really Need?
Collateral Required for Different Types of Business Loans
Collateral is an asset that a lender accepts as security for a loan. Collateral for a business loan can often be required when applying for financing, but it depends on the loan type and lender you’re working with. Most traditional lenders, like banks, will require collateral for a business loan, but some online lenders offer unsecured (collateral-free) business loans.
If you’ve started perusing options for small business loans, you’re likely scribbling down lots of questions about the loan process and what you’ll need to qualify. Among them is how much collateral is needed to secure a small business loan.
The very short answer: It depends. Sometimes none at all, but other times it’s hard to put a concrete number on it.
First, it’s important to understand that before you receive any business financing from a lender, they’ll scrutinize both your personal and business finances to see if they’re willing to lend you the money. What they’re looking at to determine if you’re eligible for funds, well before you even go into the small business loan underwriting process, is your creditworthiness as a borrower.
Essentially, lenders examine your company’s revenue history, your business and personal credit, balance sheet, your equity contributions, and other application requirements. And then, either depending on the type of loan you’re applying for, or how the lender evaluates your risk as a borrower, they may also say that collateral is needed for your small business loan.
Collateral is an additional—and tangible—guarantee that their loan will be repaid. What and how much collateral is needed for a small business loan? Here’s what you should know.
What Is Small Business Loan Collateral, More Specifically?
Collateral is a property or other asset that a borrower offers in case of default on loan payments.
In plain terms, if you stop making payments on your loan for whatever reason—be it that you can’t afford them, your business goes under, or you go off the radar—then your lender can swoop in and seize that building, equipment, or whatever was offered as collateral, then liquidate it to recoup as much of the payment as possible.
A lender’s claim to a borrower’s collateral is called a “lien.”
Is Collateral Needed for All Small Business Loans?
Not technically, no.
Collateral is 100% needed for certain business loans in which you’re directly borrowing against an asset (more on that in a moment). Basically, the loan is secured by the collateral offered up by the borrower—which makes it much lower risk for the lender.
There are other situations, however, in which a loan isn’t explicitly a collateralized loan product—what you’d picture a as a traditional bank loan, for instance—but as a borrower, you’ll be required to put up collateral, even if you’re not borrowing against it, to mitigate the lender’s risk.
An important note: Just because you don’t explicitly offer collateral to secure a small business up front doesn’t mean that your business or personal assets are safe from seizure if you default on your loan. Offering collateral puts you in control of what gets seized should you default on the payments.
Whereas if you default on an unsecured business loan and a lender needs to recoup losses, it’ll be at the lender’s discretion, as well as any other legal parties involved, to determine what gets seized. This is known as a “general lien” on business assets.
Why Would You Want to Secure a Small Business Loan Using Collateral?
The simple reason is that offering sufficient collateral for a loan could help you qualify for a higher loan amount, longer repayment terms, and a lower interest rate. Plus, it’ll generally make you look more creditworthy to a lender. It’s a promise that yes, you’re going to repay this thing.
Basically, secured financing options are some of the best out there. And offering collateral opens up your options as a borrower and could take some stress off of your debt.
And, if you don’t have good credit history, offering up collateral might make you able to qualify for financing that might not be available to you otherwise. Invoice financing, which we’ll get to in a bit, is a great example of this—the invoice itself that you’re financing acts as the loan collateral for its own financing.
What Kind of Collateral is Accepted for Business Loans?
Whatever type of collateral you choose to secure your small business loans with, you’re essentially promising your lender that you’ll repay your loan. And if you aren’t able to repay your loan, the lender will sell off whatever you’ve pledged to try to get as much of their money back as possible.
There are lots of different types of things, big and small, that can work as collateral to secure a business loan:
Real Property
This is an overarching term for both real estate and home equity, like you might imagine, but also things like vehicles (cars, planes, trains, oh my!). The nice thing about using real property as collateral for a small business loan is it’s a) likely high worth and b) readily available.
Here’s the extreme caveat: If you default on a loan secured by real property, lender seizure of this asset is a major life-disrupting event. Also, if this is the biggest part of your net worth, losing something like a home will mean a big hit to your overall finances.
Cash
As you might imagine, you can secure a loan with your savings—otherwise sometimes known as a “cash-secured loan.” This method, generally preferred by lenders, allows them to liquidate your collateralized account in the case of a default. Which makes sense, since it’s a direct value recoup for them—they don’t have to go through the trouble of selling off an asset.
It’s obviously pretty risky business to put up your entire savings as collateral, so weigh your risks before collateralizing your cash. The upside here is that since the lender views this as low risk, a small business loan collateralized by cash generally comes with better terms.
Inventory
If you’re an inventory-based business and you’re pursuing inventory financing for the goods, the inventory itself can act as collateral in case of a default.
It’s mostly straightforward, except if a lender doesn’t view your inventory as resalable or highly valuable, you might not be able to secure inventory financing with every lender.
Equipment
Similarly, if you’re looking to finance the purchase of particular equipment, the actual equipment you’re financing can act as collateral in this arrangement.
And, interestingly enough, the particular equipment will actually affect the rate of your loan. That means that if the lender deems that whatever you’re financing has a higher potential to retain its full value during liquidation in case of a default, you’re likely to get better terms.
Invoice
As we mentioned above, an invoice can work as collateral, too, especially if you’re looking to release tied-up cash. Much in the same way, lenders can help borrowers finance invoices by collateralizing the actual invoice itself, and the lender will collect against the balance due on the invoice in the case of a default.
Blanket Liens
Like you might gather from the word “blanket,” this type of collateralization is a pretty comprehensive one. And it’s a lender’s best friend.
A blanket lien allows the lender to repossess any—and every—form of collateral a business owns in order to get its money back.
Be wary! You can lose everything if you default on your loan, and this will ravage your credit, meaning that securing a new business loan to pay off those existing debts could be really, really difficult. Lenders want to be in the “first lien position,” meaning that if they’re offering a loan to a business with a blanket lien in place, that loan will probably be very expensive.
Personal Guarantees
It’s also worth noting that you can secure a small business loan with a personal guarantee. Technically, this isn’t the same as putting up collateral, but the idea here is exactly the same—to secure the loan in case of default, lowering the risk for the lender.
With collateral, you’re offering specific assets (a car, your inventory), but in a personal guarantee, as the loan’s co-signer, you’re giving your creditors the right to seize any and all financial assets that you have now (or even those you’ll obtain down the road, depending on whether the guarantee is “limited” with a cap, or “unlimited,” and we don’t have to explain what that means).
What Kind of Small Business Loans Need Collateral?
We’ve already gone over the difference between unsecured and secured loans—so you’ll know that collateral is only required secured financing. But, in reality, most types of loans are secured loans in some way. So let’s talk about how much collateral is needed for these small business loans.
Asset-Based Financing
This is a type of loan that is rooted in the need for collateral. How much collateral is needed for these small business loans? It’s in the name—asset-based financing is when a borrower takes out a loan to fund a specific asset or purchase, such as equipment or inventory, and that specific asset is used as collateral.
There are a few different types of asset-based financing on the market:
Equipment Financing
With asset-based lending, a borrower generally receives a lump sum from a borrower to secure a targeted asset. This kind of small business lending usually takes the form of equipment financing.
Secured Business Lines of Credit
Similar to asset-based loans, secured business lines of credit let borrowers receive a credit line instead of a lump sum. With this collateralized business line of credit, borrowers can not only get higher amounts to borrow but also lower interest rates. Secured business lines of credit are generally also revolving lines of credit, which means that they’ll re-up as soon as they’re repaid.
Accounts Receivable Financing
Also called “invoice financing,” accounts receivable financing uses your business’s unpaid invoices as collateral for a loan to help even out cash flow. The loan is repaid once the invoice is paid in full, with the lender taking a small percentage (or factor) from each invoice.
Term Loans
Traditional term loans will also generally require collateral from a lender. Since these are the hardest loans to secure with the best rates—especially SBA loans—your lender will ask for collateral of some sort to minimize their risk.
How Much Collateral Is Needed to Secure a Small Business Loan?
We’ll emphasize again that there’s no magic formula for this. How much collateral a lender will require from a borrower to secure a small business loan is highly contingent on not only what kind of financing the borrower is looking for but what kind of credit track record they’re bringing with them.
In Some Cases, There’s No Specific Number
Many traditional lenders, plus some alternative online lenders, don’t require specific collateral, but rather require a blanket lien on your business assets (without valuing those business assets), plus a personal guarantee to secure the loan.
Blanket liens and personal guarantees may make it easier—and, in most cases, faster—to qualify for the small business financing you’re looking for, depending on the nature of your business and your business assets.
Although we did mention that blanket liens and personal guarantees can be risky for some, the upside to this open-ended system is that it lets many lenders make more capital available to small business owners who don’t have the required tangible business assets needed to collateralize a loan.
But When You Can Get Specific, How Much Collateral Is Required?
Everyone say it together now… it depends!
Often your lender requires collateral worth more than the amount of the loan, and will only accept a certain percentage of the value of that asset to secure the loan. For example, if you have a piece of real estate worth $100,000, you won’t quite be able to secure a $100,000 loan against the real estate as collateral. This generally has to do with depreciation, and the risk the lender takes of not being able to liquidate the full value of your collateralized asset on default.
Asset-Based Lenders
For small business loans financing specific assets, you’ll need exactly as much collateral as you’re borrowing for. And that’s the arrangement in and of itself—as the lender is lending based off of a specific item (in turn, the collateral), that’s exactly the loan size you’ll get.
Traditional Lenders and Banks
Banks generally lend based off of cash flow but require collateral behind it, as well. Depending on the type of asset you’re offering as collateral and your equity ownership within it, banks will generally accept:
- Inventory with broad market potential – 50%
- Inventory with a specialized market – 0%
- Equipment – 40%
- Accounts receivables – up to 80%, contingent on your customers’ creditworthiness
- Commercial real estate – 60% to 70%, but only if your cash flow is extremely strong
Additionally, depending on the value of the assets used, borrowers can offer multiple assets to help secure a loan.
How Do Lenders Determine the Value of an Asset Used for Collateral?
Collateral value is determined by appraisal from a licensed expert during a “certified appraisal.” Your lender will likely provide their own appraiser for valuation—though you’re welcome to negotiate their findings either with your own appraiser or your own legal counsel if you think you’ve been undercut.
Appraisals are required for most loans that use collateral and asset-based financing.
So, How Much Collateral Does a Borrower Need for a Small Business Loan?
It depends on the type of loan, and may not be necessary at all.
Sometimes your loan won’t be collateralized against a specific asset at all, and it will just be covered by a blanket lien in case you default and have no other way to pay back a lender. Or perhaps you’re pursuing specific asset-based lending in which you’re collateralizing against the asset you’re financing.
It’s important to work with a small business lending professional to figure out how your business’s assets can work in your favor by securing a loan—and what work-arounds exist if you lack sufficient collateral for the loan you want.
Meredith Turits
Meredith Turits is a contributing writer for Fundera.
Meredith has worked as a writer and editor for more than a decade. Drawing on her background in small business and startups, she writes on lending, business finance, and entrepreneurship for Fundera. Her writing has also appeared in the New Republic, BBC, Time Inc, The Paris Review Daily, JPMorgan Chase, and more.