What is Collateral, and Do You Need It for a Business Loan?

What is Collateral, and Do You Need It for a Business Loan
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Collateral, or the assets put up in guarantee of repayment on a loan, is often required for loans of all types, including business loans. It’s one of the ways in which lenders reduce the risk to themselves from loaning out their money.

Yet, loans backed by collateral present significant risk for individuals and small business owners. In this guide, we’ll tell you how to obtain a business loan without collateral. 

We’ll also look at why banks typically require collateral on their small business funding options, and the downsides for borrowers. 

Most importantly, we’ll highlight one useful collateral-free alternative option – a merchant cash advance or merchant loan – and explain how it works, and the businesses that may benefit from this kind of business loan without collateral.

What is Collateral?

Collateral can be many things to many people. In the context of lending, collateral is typically an asset or group of assets that are used as a guarantee of repayment for the loan. It protects and insulates the lender from loss.

If the borrower defaults, and cannot make the required payments, the lender can seize some or all of the collateral. This ensures that their principal and owed interest is fully repaid, regardless of the financial changes that may occur in the borrower’s life or course of business.

What is Collateral

Collateral can be many things to many people. In the context of lending, collateral is typically an asset or group of assets that are used as a guarantee of repayment for the loan. It protects and insulates the lender from loss. 

If the borrower defaults, and cannot make the required payments, the lender can seize some or all of the collateral. This ensures that their principal and owed interest is fully repaid, regardless of the financial changes that may occur in the borrower’s life or course of business.

As such, collateral-backed loans, known as secured loans, are a lower risk for lenders, and typically have lower interest rates for borrowers reflective of this lower risk. 

They’re a reasonable source of small business funding, assuming you can qualify for these kinds of small business loans and have sufficient collateral that you are also willing to risk. 

However, they do require collateral, and present a higher risk for borrowers if they default, which is why many lenders – particularly non-bank, alternative lenders – provide unsecured small business funding options instead. 

And, that’s also why many small and medium-sized business owners prefer unsecured small business funding or business loans without collateral – there’s no risk of losing valuable assets worth several times the loan amount if the business suffers a downturn and the loan defaults.

Commercial Business Loans from Banks and Financial Institutions

Banks and traditional financial institutions most often require collateral for their business loans and credit products, whether you are looking for small business funding or funding for larger, well-established firms. 

They are very risk-averse when it comes to lending, and small business lending especially is considered high-risk. Collateral ensures that they will recoup any money that they lend out, usually with interest, in the event that your business fails.

Commercial Business Loans from Banks and Financial Institutions

It’s a matter of protecting themselves and their money, and not about servicing your business needs. 

Many business owners do not want to put up collateral for their loans, especially given the risky nature of small businesses in general, and so instead prefer business loans without collateral.

There are many kinds of business loans and credit products available that do not require collateral. Many function just like their secured, collateral-required counterparts, but have a slightly higher interest rate to offset the increased risk for the lender. 

Unsecured small business loans are an example of a business loan without collateral that is available from many non-bank alternative lenders. 

Another popular alternative way to obtain a business loan without collateral, that is somewhat different and doesn’t have a secured counterpart, is a merchant cash advance, also known as a merchant loan.

An Alternative Small Business Funding Option: Merchant Cash Advances

Merchant cash advances work in a manner similar to a loan, but with some key differences. They provide an up-front, lump-sum amount of cash to a business owner, similar to most kinds of small business funding and loans. 

This can be substantial, depending on the limits set by the lender, the needs of the business, and how their financials and qualifications look to the lender during the merchant loan application process.

An Alternative Small Business Funding Option Merchant Cash Advances

However, rather than have a fixed repayment amount tied to a calendar date, merchant cash advances are repaid automatically as deductions against future credit and debit card sales. A percentage of each sale is used to pay off the principal and interest on the merchant loan. 

The schedule is tied not to a calendar date, but directly to the sales being made. This makes merchant cash advances very advantageous for businesses, as they never owe payments in a given period that they cannot sustain. If sales are high, repayments are high. 

If sales decrease, repayments decrease. It’s a very responsive way to obtain small business funding, and offers advantages for many businesses compared to business loans without collateral. It’s also incredibly low-effort on the part of the business owner. 

Once set up, merchant cash advance repayment is effectively automatic and effortless, leaving business owners to focus on other, more important things than making repayments by a certain date or going online to pay the bills.

Of course, merchant cash advances aren’t necessarily suitable for all businesses. They require that a good portion of your business revenue is generated through credit or debit card sales to consumers. 

If your business doesn’t fit that profile, then a more traditional small business loan without collateral might be a better option. 

However, if your business does fit that profile, then you should seriously consider a merchant cash advance as one of the best ways to obtain a business loan without collateral, with flexible repayment terms and limited risk to your business. 

They’re ideally suited for businesses like small shops and boutiques, restaurants and bars, food trucks, mobile vendors, and service businesses that do direct sales to consumers and generate most of their revenue via plastic rather than cash, checks, or electronic transfers.

If this sounds like your business, then a merchant cash advance or merchant loan may be the best way for you to access a business loan without collateral, while avoiding looming repayment dates that you may not be able to meet. 

They are especially useful for cyclical or seasonal businesses, or those with irregular payment and revenue streams and cycles, since the repayment is tied to the sales rather than the calendar.

Business Loans Without Collateral from BizFly Funding

If you’re looking for a business loan without collateral, or really any kind of small business funding product, then look no further than BizFly Funding. 

BizFly Funding is a premiere, US-based private lender, focusing exclusively on providing small businesses with the funding they need to thrive. 

To learn more about the advantages of BizFly Funding, or to fill out the online application, visit BizFly Funding’s website at https://bizflyfunding.com.

Frequently Asked Questions about Business Loans and Collateral

Small business funding options are available in both secured (collateral required) and unsecured (without collateral) varieties. 

Business loans without collateral can include unsecured small business loans, lines of credit, and the aforementioned merchant cash advances or merchant loan products. 

Their availability will vary depending on the lender, applicant, and loan details. Usually, banks and financial institutions are more likely to require collateral, whereas non-bank private lenders are more likely to offer business loans without collateral.

The amount of collateral you may need for a commercial business loan will vary depending on the lender, the amount of the loan, and other details. 

Of course, if the lender offers unsecured small business funding, you will not need any collateral at all. 

If collateral is required, it can vary considerably, with as much as 3 to 5 times the value of the loan in collateral (based on the way in which it is valued, often well less than the purchase price or how you may value it on your business books).

Many non-bank, private lenders offer business loans without collateral, along with other kinds of small business funding without collateral. 

These can include lines of credit, debt consolidation loans, short-term loans, and merchant cash advances, among other products. 

They are far more likely than banks and traditional financial institutions to offer these business loans without collateral, based on the nature of risk tolerance and the market role that alternative lenders fill.

The assets that can be used as collateral for a commercial business loan will vary based on the requirements of the lender. 

Typically, there will be a valuation process, which assigns a fair market value to the assets to determine how much they count towards the collateral requirements.

Property, vehicles, equipment, and inventory are typical assets that may be used for collateral for small business funding purposes.

To obtain a business loan without collateral, you want to apply for an unsecured business loan or other unsecured small business funding product. 

Just be sure you meet the lender’s minimum requirements of eligibility, and fill out their application.

Alternative, non-bank lenders typically offer business funding with bad credit, business loans without collateral, and a range of different small business funding options to suit your needs.

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