Three Types of Collateral to Consider for Business Loan Approval
In the small
business ecosystem, financing remains paramount. Raising different forms of
capital is critical at every milestone in the map of your business. SCORE
mentor Hal Shelton urges small business owners to allow for up to two months of
lead time, especially if they’re seeking bank loans:
“A common
axiom is that the best time to obtain funds is when you don’t need them. Sounds
counterintuitive, but during these times you aren’t desperate to take the only
offer made. You have time to shop for the best source, with the best terms, and
you can negotiate from a position of strength.”
If your
business has made promising advances toward growth and stability, future
attempts to secure financing may be met with fewer reservations from lenders.
Assured by your positive standing, a lender might approve an unsecured line of
credit, installment or balloon loan that forgoes the need for collateral,
defined by the U.S. Small Business Administration (SBA) as “assets pledged by a
borrower to secure a loan or other credit, and subject to seizure in the event
of default.” But if you’re new to business ownership, it could be a different
story.
As an
unproven entrepreneur eager to launch a catering service or accounting
practice, you’ll need to raise financing and proceed with adequate funds at
hand. But given your minimal track record, the loans you could be approved for
will likely be secured loans, which require pledged collateral. Your collateral loan management, along with your other
vital C’s — capital, capacity, and character — will play an important role in
your lender’s review and affects not only the onset of your business but
later, its growth and sustenance. The domino effect is clear: Without viable
collateral, you’re less likely to gain approval for financing, and without
financing, you might not be able to address any of the pressing operational
needs or ongoing costs of your business. So carefully weigh the types of
collateral to leverage during your loan application process. Some are widely
acknowledged, others are misconstrued and most have their share of pros and
cons.
1. Personal Real Estate.
Using
personal real estate as collateral is common practice for prospective business
owners focusing specifically on secured loans. The SBA, a widely acknowledged
provider of secured loans, partners with lending institutions to set
competitive terms and benefits and offers a high loan-to-value ratio for your
real estate, often up to 80% of its appraised value.
But personal
real estate comes with risk. Since it’s considered an illiquid, or fixed asset,
and its value is prone to fluctuations, your real estate may be worth less over
time. And if you do fall behind on your loan payments, you risk losing your
real estate through repossession or sale. The good news is, that housing prices
remain on the rise. Now might be an opportune time to leverage your home equity
as collateral, especially, as the housing market appears to show strength.
2. Cash From Your Accounts.
Unlike
personal real estate, cash from your business or personal savings account is a
liquid asset. Since a lender deems cash as concrete and accessible collateral —
it’s also assumed to be held in accounts with the said lender — you may be
categorized as a lower risk, and as a result, offered more favorable interest
rates with flexible repayment terms designed to help you accelerate your credit
building and increase your credit score. These are all positives that work in
your favor. Nonetheless, a downside remains: If you default on your loan
payments, your lender can easily seize the cash funds in your account, and you
might lose your savings entirely.
3. Accounts Receivables.
If you’re an
owner trying to stay afloat during a particularly volatile season and require a
best place for
short-term loans
boost of funding to quickly stabilize your cash flow, pledging your accounts
receivables as collateral may be the most efficient way to secure the financing
you need. By leveraging your unpaid invoices as assets, you can access the
necessary cash from your lender without the risks associated with pledging
personal real estate. However, since your lender will likely vet your total
invoices — rejecting overdue accounts and narrowing the sum to a select number
— the final percentage of your loan may be between 75–85% of your invoices’
value.
Accounts-receivable
factoring, on the other hand, involves the sale of your receivables outright to
a third-party company, known as a factor. In return, the factor advances your funding based on the discounted value of receivables purchased. When your
receivables are finally settled by your customers, the factor then returns the
outstanding balance to you (minus a one-time fee typically assessed for the
service). In this way, factoring companies function as your business’s credit
manager throughout the process. With accounts receivable factoring, you benefit
from a quick approvals process and no accruing debt to repay. You can also
access as much funding as the value of your
receivables allow.
But
factoring may have its disadvantages. Once they’re alerted to your factoring
arrangement, your customers are then required to settle outstanding receivables
with your factor, not you. This may raise red flags about the general health of
your cash flow. Accounts-receivable factoring also favors B2B
(business-to-business) practices, which generate large numbers of unpaid
invoices. So, if you’re a small business owner in the retail space who
interacts directly with your consumers, factoring may not be a viable option.
The process of selecting and pledging your collateral, which shows your ability to repay, also reflects your strategic foresight to identify and meet financing needs, so that your business can continue to thrive at every point in its journey. Popular Bank COO Manuel Chine encourages a business owner to consider two pertinent questions, in relation to the cycle of borrowing, financing, leveraging, and repayment.
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