SBA backed loans: Everything You Wanted to Know About Collateral Requirements but Were Too Afraid to Ask.
Requirements for loans can be overwhelming or confusing, especially when it comes to the question of collateral. Different lenders and types of loans can all have different requirements. These differences depend on how much you’re borrowing and for what, what type of collateral you’re offering, and what sector your business is in.
Here’s an overview of collateral requirements to help guide you through the process.
What is it?
Collateral is simply security for your lender. It makes them comfortable lending to you because it proves that you have a way of paying back the loan other than with income from your business (if necessary).
Since small businesses are generally considered to be riskier borrowers, the Small Business Association offers lenders further assurance with SBA-backed loans. These loans have strict collateral requirements.
Collateral can come in the form of an asset you already own (like a piece of equipment or property you own outright) or an asset you still have a loan against (like a house you have a mortgage on). It can be an asset owned by your business or owned privately by you.
To secure loans, businesses and their owners can use property with equity in it, cash savings or deposits, business inventory or equipment, and accounts receivable.
Why do they need it?
Collateral is one of many factors the lender has to consider when deciding whether (and how much) to lend. It contributes to the larger picture of whether or not you will be able to repay the loan they’re giving you, even in the case of unforeseen circumstances. The SBA says it will not generally decline a loan when the only unfavorable factor is a lack of collateral, but most loans will require some form of collateral to ensure repayment.
Small business owners who own more than a 20% share of the company must each provide personal guarantees. This is true for all SBA-backed loans and assures that the principals are all invested in the repayment of the loan.
How much do they need?
The amount of collateral needed depends on the size of the loan, of course, but also on the term of the loan. For SBA-backed loans between $25,000 and $2,000,000 most lenders will require all business assets to be pledged as collateral, as well as the owners’ personal assets, depending on the amount borrowed.
The SBA requires small business owners to pledge their homes (if they own it) as collateral for all the loans it backs. This might be surprising, especially if you are borrowing far less than the value of your home. Consider, though, that the SBA is guaranteeing banks at least a partial repayment of these loans, and if you default without collateral, that means taxpayer money is going to repay your loan.
By requiring that you pledge major collateral (both from your business and personally), the SBA is ensuring that you are fully committed to this venture; it will always be more painful for you to default on the loan (and lose your house) than it will be to keep paying the loan back.
It’s not always necessary
Some alternatives to loans are available without collateral. Peer-to-peer lending, merchant cash advances, and invoice factoring are some of the options for companies that want to borrow smaller amounts of money without offering up personal property as collateral.