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Unsecured Business Loans

Unsecured Business Loans: Collateral-Free Financing

Getting a business loan can be an uphill climb for new small businesses. That climb is intensified when the business or its owners don’t have valuable collateral to secure the loan. Like any financing method, unsecured business loans have benefits and drawbacks. They make sense for some businesses in certain situations and not for others. With thorough research and thoughtful consideration, you’ll be able to determine whether an unsecured business loan is right for your company.

What are unsecured business loans?

Often, lenders will require that a business put up collateral to back a loan. The collateral can belong to the business owner or to the business itself. Collateral is typically an item of great value, such as real estate or a vehicle. If the business defaults on its loan, the lender can take possession of the collateral and sell it to make up a portion of its loss. A loan that is backed by collateral is considered secured. A loan that is not backed by collateral is considered unsecured. Sometimes an unsecured loan is called a “signature loan,” as all the lender has to back the loan is your signature on the paperwork.

Since putting up collateral takes some of the risk out of the loan process for the lender, secured loans usually feature better interest rates and fewer fees than their unsecured counterparts. Unsecured small business loans are usually off-limits to businesses with low credit scores. However, if your business is in good financial standing, an unsecured business loan can be a good option.

Secured loans do add a significant risk for borrowers. If a business faces hard times and must default on its loan, it risks losing other valuable collateral essential for operations, which can make getting back on track even more difficult. If owners put up personal property as collateral, they risk financial demise by losing their business and potentially their home.

Pros and cons of unsecured business loans

In addition to the risk factors mentioned above, there are a number of other potential advantages and detriments of obtaining an unsecured business loan.

Advantages of unsecured business loans

  • With an unsecured loan, your assets are not directly at risk as collateral.
  • Businesses can borrow a larger amount of money with an unsecured loan. This is because secured loans are limited by the value of the collateral used to secure it.
  • The application process is often less intensive for an unsecured business loan, involving less paperwork and requiring businesses to submit less documentation.
  • Unsecured business loans are generally funded faster since they skip the step of collateral appraisal.
  • Like most loans, an unsecured loan gives your company an infusion of cash that enables greater flexibility to cultivate your business and grow faster.
  • For new companies, taking out an unsecured loan can help forge a relationship with a lender and build good credit. Even though the costs surrounding the loan might not be ideal, if managed responsibly, an unsecured business loan can open the door to more and different financing options in the future.

Disadvantages of unsecured business loans

  • Unsecured small business loans come at the price of a much higher interest rate, even if your business has good credit.
  • Term length of an unsecured business loan is often limited to 5 years. Secured loans are more flexible and can last 30 years and beyond if necessary.
  • Unsecured business loans typically have stricter terms and penalties for things like early repayment.
  • Since there’s nothing backing your loan, lenders might not give a lot of leeway when it comes to late payment. Once you start showing signs of possible default, your lender can halt your loan and send you to collections. This can be damaging to your credit score and the reputation of your business.
  • Even though unsecured small business loans don’t involve collateral, if you personally guarantee your loan, you are responsible for repayment if the business defaults. This means if you don’t pay, the lender can still come after your personal assets.

Are unsecured business loans hard to get?

Unsecured small business loans are not difficult to attain if you have good credit. If your credit is not great, it can be more of a challenge to find a lender willing to give you an unsecured loan. Since an unsecured loan is backed by just your good word, lenders want to see that you’re responsible with money and have a track record of managing debt responsibly. Without a strong credit rating, lenders don’t have proof that you will treat their investment sensibly.

Though it might surprise you, your assets are not completely off the hook with an unsecured loan. If a borrower defaults on an unsecured business loan, it’s true that the lender can’t repossess collateral to recover any losses. However, it can take the borrower to court or to collections. As a result, the borrower’s wages can be garnished, a lien put on their home or other property, or they can be ordered to repay the debt some other way. Defaulting on any loan is also very damaging to the borrower’s credit score, which will negatively affect their ability to access financing in the future.

Getting an unsecured business loan

Before pursuing any type of business loan, it’s wise to conduct some financial analysis within your business to determine how much money you need to borrow and what kind of a payment you can comfortably afford each month. Also, research the items (or services) you intend to purchase with the loan and decide on the exact figure you’re targeting. Lenders prefer a precise number to a ballpark range, so be as detailed as possible when estimating costs.

Contact the credit bureaus or sign up with a credit monitoring service to check your personal and business credit. Consider whether your score is good enough to land a decent rate on an unsecured loan. If not, take some time and dedicate it to paying down debt and improving your credit rating. Some credit monitoring services offer free education on how to better your score. Credit counselors are also great resources.

Next, research different lenders and the loan options they offer. Competing lenders might offer similar small business loans at different rates. Some lenders specialize in certain areas that could make them a better fit for your company. Online alternative lenders provide convenience. After submitting your application information, quotes come to you directly within a day. You can shop the options from the convenience of your home or office. Pick the lenders you’d most like to work with and the loan products that seem like the best match for your needs.

Start to gather the paperwork necessary for your loan application. Different lenders have different business loan requirements, but it’s worth noting that online lenders require much less! Lenders’ specific application processes will vary, but in most cases, you will need to fill out paperwork and submit a number of documents. After these are reviewed, you may receive some follow-up questions or requests for further documentation. It could take up to a month to receive an approval or denial from a traditional bank lender. Alternative online lenders move much faster and will let you know the status of your application within about 24 hours.

Once you’ve been approved for a loan, you will receive the funds almost immediately if you work with an alternative lender. It might take a week or so for the loan to fund with a traditional bank.

Documentation lenders will request include:

  • Relevant contracts such as franchise documentation or commercial leases
  • Business licenses and registrations
  • Legal proof of ownership
  • Balance statements
  • Income statements
  • Recent tax returns
  • Cash flow analysis
  • Insurance policies
  • Business plan

Alternatives to unsecured business loans

If you determine that an unsecured loan is not right for your business and you don’t have traditional collateral to back a loan, there are several other loan options to consider that use alternative backing methods.

  • SBA loans: The U.S. Small Business Administration (SBA) offers programs that guarantee the loans of small businesses. What that means is, should the business default, the SBA will pay a portion of the outstanding balance back to the lender. The SBA provides this service to encourage lenders to work with small businesses, which are traditionally risky investments, in order to stimulate entrepreneurship and the economy. While the SBA will use a company’s collateral to secure a loan, if that’s an option, they won’t deny a company because they lack collateral.
  • Equipment financing: Purchasing equipment is one of the biggest investments a business will make. These loans are easily accessible to small businesses, even to those with no collateral and less-than-ideal credit, because the equipment itself is used as collateral. The business pays off the cost of the equipment each month (plus interest). If the business defaults, the lender repossesses the equipment and sells it to recoup its losses.
  • Accounts receivable financing: In this option, a business’ invoices are used as collateral. Also called invoice factoring, accounts receivable financing involves a business selling its existing invoices to a factoring company. The business receives money for the invoices upfront (minus fees) and the factoring company collects on the invoices.

Determining whether a secured or unsecured loan is right for your business can be challenging. Once you’ve assessed your current financial standing, your comfort level with risk, and where you hope to take the company, you’ll be equipped to determine the best financing choice for your small business.