Being a business owner comes with a lot of risks and it takes a lot of dedication to pursue your dream and turn it into a success. But when the time comes for you to apply for a loan to expand your business, there’s one obstacle you might encounter: collateral.
Many lenders require borrowers to put up a valuable asset as collateral. But with all the hard work you’ve already put into your business, it simply might not be possible for your business to own things like real estate or vehicles.
If you need a business loan, but want to avoid having to deal with collateral, one option to consider is an unsecured loan.
What Is an Unsecured Business Loan?
An unsecured business loan is a type of loan that does not require the borrower to put up a major asset, such as real estate, a vehicle, or expensive business equipment as collateral to secure the loan. Business loans that do require the borrower to put up collateral are known as secured loans. It’s important to be aware that if a borrower defaults on an unsecured loan, it is still possible for a lender to seize assets to recover their losses.
Pros and Cons of Unsecured Business Loans
Unsecured business loans can be particularly appealing to small business owners who simply might not be able to own the types of assets banks look for to be used as collateral. If the business owner has personal assets that could potentially be used for collateral, they might not be comfortable with the idea of risking personal assets to fund business ventures.
Since unsecured business loans involve a higher risk for the lender, lenders place a great deal of emphasis on credit scores when evaluating loan applications.
Because of this, it can be difficult for business owners with less-than-ideal credit scores to obtain an unsecured business loan. Given the higher risk that comes with offering unsecured business loans, interest rates can be higher than they would be with secured loans.
Although unsecured business loans are riskier for the lender, the approval time can actually be shorter than it is for secured loans. When a loan is secured by collateral, the asset needs to be appraised to determine its value, but there’s no need for that step when collateral is not involved.
Types of Unsecured Business Loans
Just because a loan is unsecured, that doesn’t mean lenders are powerless to collect if a borrower defaults on the loan. There are a few different types of unsecured business loans: blanket business lien, unlimited personal guarantee, and limited personal guarantee.
If an unsecured business loan has a blanket business lien, the lender is able to seize and sell assets belonging to a business to recover their losses. A personal guarantee means the lender can come after assets belonging to the individual borrower, not the business, to recoup their losses.
With an unlimited personal guarantee, the lender can come after any of the borrower’s personal assets to recover the amount they’re owed, plus interest and any legal fees they incur in the process.
Limited personal guarantees are primarily used by businesses that have multiple partners and there are two types of limited guarantees: several guarantees and joint and several guarantees.
With a several guarantee, each partner is liable for a set percentage of the amount owed. In the case of a joint and several guarantee, a lender can try to recover losses from all of the business partners or any individual partner, meaning it is possible for one partner to be liable for the full amount owed.
There are other types of business funding options that typically do not require the borrower to put up extra collateral. With invoice financing and equipment financing, the deals are respectively secured by the invoices and equipment, so the borrower does not have to put up anything else.
Applying for an Unsecured Business Loan
Since an unsecured business loan involves a higher risk on the lender’s behalf, lenders put a great deal of emphasis on credit score and business performance. All lenders have their own criteria they look for, but they typically consider things like how long a business has been operating for, business revenue, credit score, and your business plan.