How Hard Is It to Get an Unsecured Business Loan?
What is Unsecured Business Loans
It is any business funding that you can access without collateral. It works like personal credit cards, but on a business level. These loans include unsecured term loans and business lines of credit.
Now, as expected, unsecured business loans are quite risky for lenders. For it is most likely that the borrower will default. Yet, some lenders are willing to take such risks and extend credit or loan facilities purely based on the creditworthiness of the business. Only, such lenders charge higher interest rates to compensate for the risk. Such lenders include Kabbage, OnDeck, Street Shares, and Fundbox.
How Do Unsecured Business Loans Work?
Here is the thing. If you were to approach a bank for a secured business loan, you would need to offer collateral whose value is equal or more than the loan amount. Then, should you default on your repayment terms, the bank can get a court order to seize the assets that you placed as collateral. That way, the bank can liquidate the assets and use the proceeds to offset the loan balance.
In contrast, when getting an unsecured business loan, there is no collateral. Then, what happens when you are late on your repayments? Here, some special conditions are synonymous with such high-risk funding as follows:
- The lender can opt to increase the interest rates due to the defaulting.
- Some lenders insist on a personal guarantee. Here, the business owner commits to settle the debt using his private assets if the business defaults. Note that it is only shareholders or directors with 20% to 25% shareholding in limited companies and LLPs that can provide a personal guarantee. A sole trader or partner will have personal liability for the loan.
- Others ask for a general lien on all your business assets. This blanket lien gives the lender the legal claim to all the company assets should you default on the loan.
Requirements from Lending Institutions
An entrepreneur will have limited options when sourcing for unsecured business loans. Indeed, the traditional lenders that comprise mostly of banks, microfinance institutions, and crowdfunding sites ask for specific collateral like real estate property, company vehicles, plant, and machinery. Plus, they also take into account other factors like the credit repayment history, the company's business score, and current financial standing.
A typical lender willing to advance an unsecured business loan will look at other factors like the company's cash flow history, annual revenues, the owner's credit score, and the number of years or months in operation. The cash flow is a good indicator of the company's ability to anticipate and meet their short term cash obligations. The annual revenue report gives a picture of the general health of the business. And, a personal credit score indicates the owner's willingness to meet their financial obligations. Even so, if one qualifies for such a loan, due to the high risk, the repayment period is shorter than that one given for secured loans.
Implications to the Small Business Owner
Unsecured business loans grant your fast access to funding at a time when most lenders turn down your request for cash. Hence, one can get the loan within days or hours after the loan application. Such a quick loan is vital when you want to top up your working capital, add critical assets, expand your business, or refurbish it. However, the entrepreneur should weigh the trade off against the expected return.
How will the high-interest rates affect your business cash flows? More so, can you service the loan within the short term given by the lender? And, how will the blanket lien affect your business in the event of a default?
Alternatives to Unsecured Business Loans
Finally, what if you do not qualify for both secured and unsecured loans? What are your remaining options for obtaining funding for your business? In such instances, consider getting a merchant cash advance. Or, approach a business payday lender for a short term cash advance. These alternatives are at a higher interest rate than the conventional unsecured loans. Plus, the borrower has to agree on automatic withdrawal terms from the business's current account.
Every business owner must use a business loan to his advantage. Hence, it is prudent to get funding with the best lending terms. But, without collateral, a small business owner will have to dig deeper into his pockets as he tries to service the loan. Unsecured business loans don't come easy. With such requirements as a blanket lien on all company assets, these options are risky for a startup. Hence, the business owner must weigh his options appropriately.