Finance and a business go hand in hand. As with an individual, a business may also come up with requirement of credit at any time. As funds required for a business would be in greater proportion in comparison to an individual's requirement, the loan requirements vary as well.
Loans for business could come in 2 forms: short-term loans and long-term loans. Short-term loans can range between 1-3 years and the amount involved is also lower. Hence, they may be lent without any collaterals. However, long-term loans involve longer tenures as suggested by the name and also involve higher amounts. Hence, they may be approved only against a collateral or security. As collateral or security is involved, the loan is also referred to as a secured loan.
However, lenders do not strictly follow the criteria of the duration of the loan while asking for collateral. If they have doubts regarding assured repayment of the loan, even short-term loans may be lent on a security.
There may also be the case when the credit score of the business is low or the business is not financially sound. In those cases, even a small loan may be lent only on the basis of collateral security.
Additional Reading: Collateral Free Loan
Types of Collaterals
Businesses, especially small and upcoming businesses, have a lot of need for funds. However, they find it difficult to provide collateral to the lenders. Services-based businesses also find themselves in a tight spot as their businesses are not asset heavy to provide collaterals.
Off late, there is a lot of business lending happening without the need for collaterals by fintech/ new age lenders who base their loan approval decisions on their proprietary algorithms and other criteria for lending. However, the interest rate offered by them may be a tad higher than the traditional lenders like the banks.
To help you in situations like these, we bring a comprehensive list of collaterals that you can offer when availing a secured business loan. You would notice that many on the list may be easily available with you, but you may never have thought of offering it as a collateral.
Here are the collaterals accepted by lenders for secured loans:
A real estate property may be one of the biggest asset you may own. If you happen to own a building, office premises or even a factory, the same can be pledged with the lender for borrowing funds.
This is also called Loan Against Property. Lenders mostly keep a margin from 25-40% of the assessed value of the property and lend the remaining as loan. The margin amount is decided based on factors like the age and condition of the building, a clear title deed, etc.
A property may be a good option as a security, but your business would need to have a solid repayment plan in place.
Second Charge/ Mortgage on a Property
This type of collateral also works like a loan on property, but the main difference between the two is that you are mortgaging the property which is already mortgaged with another lender for a different loan. For Ex: A small business owner might have mortgaged his house for a home loan but may be in need of some funds for business expansion after certain time has elapsed since his first loan.
If he meets all other clauses like a good credit score, sound business financials, etc., he can approach the same lender or a different lender for a second mortgage against the same property. A second charge on the property can be created by the second lender after signing a Pari Passu agreement for creating lien on the property in proportion to the loans lent by them.
Additional Reading: “No collateral” loans for starting your new business
A business owns inventory for sale or for its own use. It may also have equipment especially if it is involved in manufacture. In these cases, the inventory or equipment it holds could be used as collateral for getting a business loan.
This can also be used when a business needs finance to buy an equipment. The same equipment may be hypothecated to the lender to obtain finance. The risk here would be loss of equipment or the inventory which has been pledged if repayments are not on schedule.
If the business organization is sure of repayment, then inventory or equipment financing is a good way of raising finance because the equipment could be put to use at the same time.
Invoices are your accounts receivable. Unpaid invoices for which the payment is yet to be made is considered as an asset of the business. Lenders accept the security of invoices to offer some financing. Under this arrangement, the accounts when paid in will be received directly by the lender, if you do not pay up the EMIs.
However, there is always a risk that your debtors may not pay up the amount due to your business, hence the loan to value ratio in case of invoice financing may be lower than what you get in case of equipment or inventory financing.
This may not exactly work like a collateral. But, financing is available on guarantees of individuals or other businesses. In this case, in case the business fails to pay up the amount due to the lender, then the guarantor can be made liable for clearing the loan.
This arrangement works when the business is small/ runs as sole proprietorship concern, wherein another individual can vouch for the business.
Additional Reading: Startup Business Loans Bad Credit No Collateral
Stocks and Shares / Insurance Policies
A business may hold some investments in shares or insurance policies (endowment or moneyback). These investments are eligible for pledging as a collateral for availing business loans.
The rule of margin is considered here, as the value of investments are subject to market risks and fluctuations. This margin may go on to as low as 50% too in case of certain company stocks. A business has the flexibility of offering a variety of collateral for obtaining finance. However, the bottom line remains that the business needs to repay the debt on time or risk losing the asset.
Therefore, it is always good to borrow only as much as a business can comfortably repay.