Collateral for Business Loans

Collateral for Business Loans
Collateral for Business Loans. Spaces Images/Getty Images

What is Collateral? 

Collateral describes the assets you pledge to a bank or other lender in order to receive a loan. In this article, we'll discuss collateral specifically for business loan.

The Small Business Administration says

Collateral is an additional form of security which can be used to assure a lender that you have a second source of loan repayment.

Let's look at this definition of collateral in more detail.

 

How Collateral Works

You want a loan to start or buy a business. So you go to a bank, credit union, or other lender. The lender wants to know how much you want to borrow, and it also wants to know that it will be paid back the money owed, if the business isn't successful. 

Remember that small business loans are the most risky loans a lender can take on. It's difficult to walk away from a home (you need somewhere to live), so a home loan is less risky. But if a business owner doesn't have any money in the business, he or she can walk away and leave the lender with nothing. 

Hence, the lender wants collateral. Collateral is that additional security the SBA was talking about. It's a way to "secure" the loan. A lender is more likely to agree to a secured loan than an unsecured loan.

What Can I Use as Collateral for a Business Loan? 

Collateral may include business or personal assets, such as the equity in your home or car.

The assets can then be seized by the lender if you fail to pay on the loan. If you have collateral, you can get a secured loan at better rates than if you had no collateral. Loans without collateral are unsecured loans.

One of the reasons it is more difficult to receive a loan for a startup is that there are not yet any business assets which can be used as collateral.

 If you are buying an existing business, you can use the existing assets (furniture, vehicles, equipment, a building that has been paid for) as security. 

Equity as collateral  

It's important to note that offering a business or personal asset as collateral works only if you have equity (ownership) of that asset. For example, if you have a $100,000 home that you want to pledge as collateral, and you have loans on the home for $80,000, the lender will only consider $20,000 of the value of the house as collateral. In other words, the lender doesn't want collateral that you don't own. 

How Collateral is Valued

If you have collateral you want to use for a business startup or expansion loan, you will need to have the collateral valued. The lender will want an appraisal, performed by a certified appraiser, to set the value of the asset. Be sure you have all the business records you need to prove that you own the asset, and its value.