For a small business owner, running a business comes with plenty of risks, mostly financial. So having to offer personal or business assets against new investments isn't necessarily top of your wish list when it comes to getting a loan. So how do you get small business loans without collateral?
Collateral vs Personal Guarantees
Collateral is different to a personal guarantee, if a lender is looking to get collateral on your loan and you don't have any, then it will seek to impose some sort of personal guarantee from you instead.
What is collateral?
Every 'secured loan' uses an asset as security against it. This could be property, land, stock or through shares options in the company.
If the loan goes into default then the lender can seize the collateral in lieu of payment of the loan. This obviously reduced the risk for the lender, which in turn makes the loan better value through lower interest rates, reflected in the risk/outlay by the lender.
While asset finance is typically offered with in-built security, the same cannot be said for standard small business loans and while there are many business owners who don't want to risk their business assets, there are more that don't have the assets to put up as security.
What are personal guarantees?
Personal guarantees allow business owners to access funding and loans by putting their own finances as security against any default on the loan. When default happens it results in personal loss from the business owner and a negative impact upon their credit score.
Unfortunately, for new businesses and those that have poor or limited credit and trading history, it is hard for lenders to agree funding without a personal guarantee.
For business owners, this means signing over the legal responsibility for their business loans onto their personal assets. It can also mean the banks will seek to extend their legal entitlement, not just on their assets but also spouse and family assets too.
For joint business owners any personal guarantee has the potential, depending on the contract details, to allow the bank to pursue 100% of the debt from a single partner if the others either cannot or do not have the facility to pay.
Why You Don't Want A Loan With Collateral
While secured loans are often the best, sometimes businesses don't have a choice and can feel forced into accepting small business loans with personal guarantees attached.
This doesn't have to be the case. Here are three reasons why you might not want to take a loan with collateral:
- You don't hold enough business (or personal) assets
- You don't want to risk your business (or personal) assets
- The banks will under-value your assets anyway.
The reason banks like to have collateral, even though they really don't want the trouble of repossessing and selling off your assets, is because they also have to borrow money (from other banks). And their finance is controlled by how extensive their own liabilities are! Remember the whole banking crisis was brought about by (subprime) mortgage lending in America whose financial collateral just didn't add up.
Alternatives to Small Business Loans Without Collateral
Most small business loans that don't require collateral will still ask for personal guarantees, however there are still types of small business finance that offer funding without either:
Peer-to-Peer Finance - Requires cooperation between individuals, usually using an alternative, online lending platform. Individuals investors provide the cash based on the business plan of the applicant. Again the interest rates and terms of the loan are often dictated by the viability of the business to pay back the loan which is usually closely related to its credit history.
Equity Finance - Again not strictly a small business loan, but a way to generate finance for your business when you have no collateral, no personal security and no trading history. However in this instance in exchange for investment, you are permanently offering up a portion of your business. This is domain of angel investors.
Crowdfunding - Has grown in popularity where individuals, both public and private business investors can come together to fund a business. Although be warned, unless you have time on your hands and either a flair for marketing or a sexy tech product then it won't be suitable for all business types.
Cash Advance - Not loans, but vehicles for finance that offer upfront finance (an advance of money) in return for a percentage of the daily/weekly sales you make, until the agreed finance, plus interest, has been paid back.
How to Get Small Business Loans Without Collateral
It is possible for almost any business to get an unsecured business loan. And while they do not require either collateral or personal guarantees, they will, in return, charge higher interest rates than a traditional loan.
Approaching a bank without the due diligence of planning and a clear business plan of what, how and why you need a loan will usually be met with a firm rebuff. However, approaching an alternative lender, armed with a clear business plan can get you further than you think, regardless of your credit history or limited trading history.
What you will need to do is ensure that you are doing everything possible to improve your credit and make yourself an attractive business proposition:
1. Improve your credit report
Without collateral, there will be a greater emphasis on your credit score. Improving it will mean your chances of getting better rates increases. You can help this by paying of as much debt as you can, and keeping balances as low as possible on your credit accounts. It also helps to pay off suppliers and debtors in good time, without opening or taking on any further debt liabilities. Your credit file won't always preclude you from lines of credit, but it is the principle qualifier for the interest rate of credit offered to you.
2. Do your research
There are loans that don’t require collateral. Most of them are unsecured loans and with a bit of research you will be able to find them available. They typically have higher interest rates and shorter term lengths, reflecting the greater risks taken by lenders. But for a short term loan, an unsecured business loan can be all that you need. Taking out a loan and fulfilling the loan obligations also helps improve your credit score and provide more confidence from the lender the next time you apply. If you are prepared to do the legwork, then get online and seek out the possibilities.
3. A winning business plan
The basics of a solid business plan includes your business overview, how it makes money, a calculated growth plan, a detailed business strategy, financial statements and profit and loss statements (based on present levels and indicating how investment will change this). You also need to be clear on what you will be using any loan investment for, allocating clearly where it will go, what it will purchase and how it will increase profits. Your business plan should be a combination of reducing any perceived risk in your business as well as demonstrating profitability.
4. Look for unsecured business loans
It is possible that your business qualifies for an unsecured business loan without the need for either collateral or a personal guarantee. Your company may qualify for a loan by merit if your business exhibits any of the following traits:
- Financial records that show a historical track record of consistent profits
- Persuasive business projections
- Excellent business and personal credit record
- Strong net worth and healthy cash flow.
Why The Lending Market is Moving Towards Unsecured Loans
With more and more companies, noticeably digital and tech companies, offering products without any physical assets, lenders have needed to come up with better ways in which to offer funding.
It isn't unusual to see loans being made of over £100,000 which are unsecured, although how personal guarantees are used in each case might be an important element to consider.
Because of the need for speedy funding, unsecured loans have become increasingly streamlined, usually much quicker to arrange than standard small business loans from the bank.
- More start-ups from rising entrepreneurs
- Increased funding directed towards emerging technologies
- The move towards the digitisation of lending.
With this in mind, expect unsecured loans to become even more popular and competitive.
At the moment the biggest downside to approaching alternative lenders for loans without the need for collateral is obviously the rates. Because the lender is taking on all the risk of non-payment, rates have to be higher than that of the banks, who will ask for security.
But this is often a small price to pay for accessing the lending market and enabling businesses to grow and expand and taking advantage of time-specific opportunities. It marks the move away from longer-term secured loans to short-term unsecured loans aimed at rapid growth and exploiting profits.