There are many different types of entrepreneurs, and just as many types of startup businesses, but they all have one thing in common: the need for capital. Their business ideas may be valuable, but most aspiring small business owners don’t exactly have the funds in their own bank accounts to cover startup expenses. Sound familiar? Fortunately, a lack of capital doesn’t mean that you have to push your startup dreams to the back burner. There are plenty of startup business loan options that allow you to fund a new business without emptying your personal bank account.
There may be one thing that’s holding you back from submitting that loan application, though. If you lack collateral to back the loan, you may be hesitant to move forward with a lender. If this is a problem you’re facing, keep reading. In this post, we’re going to discuss your startup business loan options when you can’t put up collateral. We’ll look at what collateral actually is, why some lenders require it, and funding options that don’t require collateral.
What Is Collateral? A Short Primer
Collateral is a physical asset that is put up to secure your loan. It shows the lender that you’re serious about your loan and plan to make all payments as agreed. If you fail to meet the terms of your loan, you default on the agreement and the lender can seize the collateral, which is then sold in order to pay off the debt.
There are several things that can be used as collateral. Business equipment, vehicles, property, and inventory are common forms of collateral when seeking a business loan. Any property of value that can be sold by the lender can qualify as collateral, even accounts receivables.
Still scratching your head over collateral? Check out our post What Is Collateral & Do I Need It For A Business Loan to learn more.
Secured VS Unsecured Loans: Know The Difference
In your search for a small business loan, you’ve likely encountered the terms “secured” and “unsecured.” If a loan is secured, it is backed with some form of collateral. The lender will put a lien on the pledged asset and will have the right to seize it and sell it if you default on the loan. Failure to pay your loan as agreed will also negatively impact your credit score. A home mortgage is a type of secured loan, where the property being purchased is the collateral for the loan.
An unsecured loan, on the other hand, does not require you to put up specific collateral to back the loan. If you do not pay your loan as agreed, the lender can’t seize your property. However, the lender may seek a judgment against you in court if you default on your loan agreement. As with a secured loan, defaulting on an unsecured loan will affect your credit score negatively.
Do Personal Guarantees Count As Collateral?
Some lenders require you to sign a personal guarantee as a condition of receiving a loan. By signing a personal guarantee, you are making a promise to the lender that you will repay the loan. This personal guarantee takes some of the risk off the lender. If you don’t fulfill that promise, the lender has the right to liquidate personal assets, including personal real estate, vehicles, or even your personal bank accounts.
Because a personal guarantee isn’t attached to a specific asset, it doesn’t count as collateral. It does in some cases take the place of collateral when a borrower doesn’t have an asset to secure the loan. One important thing to note is that both secured and unsecured loans may require a personal guarantee. This varies by lender, so make sure you do your research before signing on the dotted line.
Most lenders require all borrowers with at least a 20% stake in the business to sign a personal guarantee. If you have a co-signer for your loan, the co-signer will typically be required to sign a personal guarantee. In some cases, your spouse may also be required to sign even if they aren’t listed on the loan. This is to eradicate any conflicts over jointly-owned property.
If you’re unsure about moving forward with a loan that requires a personal guarantee, check out our post Should I Sign A Personal Guarantee? to learn more about the benefits and drawbacks of signing.
Why Creditors Ask For Collateral On Startup Loans
So, why do most creditors ask for collateral for startup loans?
For lenders, it’s all about risk. Borrowers with good personal credit, an established business, and solid revenue are seen as less of a risk. These borrowers receive lower interest rates, higher loan limits, and loans that don’t have to be backed with collateral.
On the other hand, risky borrowers are more of a challenge. Lenders may be willing to loan money to these borrowers, but they want to mitigate risk as much as possible. This is why riskier borrowers receive lower loan limits, higher interest rates, and may be required to put up collateral. If the lender is unable to collect what is owed if the borrower defaults, the collateral can be seized and sold, allowing the lender to recover their funds.
Startup businesses are seen as a risk by lenders because they haven’t yet established a track record of success. There is no annual revenue or business credit history to consider. In other words, the lender is unsure if the borrower is willing or able to make their loan payments on time as agreed. With an asset backing the loan, lenders feel more confident in loaning to newer businesses and startups, business owners without perfect credit, and other high-risk borrowers.
The Downsides Of Getting A Startup Loan With No Collateral
If you don’t have collateral to secure a startup loan, you’re not completely out of luck. There are some lenders that will work with your situation to help you get the funds you need. Unfortunately, there are a few drawbacks to getting a loan without collateral. It’s important to fully weigh out the pros and cons of these loans before making a commitment.
Higher Interest Rates
Without collateral, your loan may come at a higher cost. Some creditors are willing to fund startup businesses with a higher interest rate than more established businesses or business owners that have collateral. These increased interest rates can add hundreds or even thousands of dollars to what you owe, so make sure you have a grasp of exactly how much your loan will cost. Then, decide if the expense is worth it, or if you’re better off taking another funding route.
Shorter Repayment Terms
Typically, loans with the most favorable repayment terms are reserved for the most creditworthy borrowers (i.e., established businesses). If you need a startup loan and don’t have collateral, you may have to take a short-term loan. Instead of paying back funds over a longer period of time, you’ll have to repay your loan more quickly — for example, three or six months. You may also be required to make more frequent payments depending on the lender you choose (such as weekly or bi-weekly instead of monthly). Again, it’s important to fully evaluate the pros and cons of repayment terms of any loan you’re offered to decide whether it’s right for your business.
Fewer Lender Choices
Look through the Merchant Maverick website, and you’ll find just a fraction of the lenders ready to work with small business owners. To qualify, though, you must meet all lender requirements. Though these requirements vary, many lenders exclude startup businesses and require a minimum time in business, such as one year. Others may be more willing to work with startups but require collateral to secure the loan. If you don’t meet these requirements, you’ll have to find another lender.
Lower Borrowing Limits
Putting up collateral means you have some skin in the game. This allows lenders to feel more confident when lending to you. With many lenders, you’ll be able to borrow more funds than you would without collateral.
In order to receive a startup loan without collateral, your application needs to be strong in other areas (i.e., a high personal credit score). We’ll go into this a little more later, but for now, just know that you may face much stricter borrowing requirements if you lack collateral to secure your loan.
Where To Get Startup Loans Without Putting Up Collateral
If the drawbacks of a collateral-less startup loan haven’t deterred you, you’re one step closer to starting the loan process. Like many new business owners, though, you may be unsure of where to acquire a loan. There are several lending options to consider.
There are a number of online lenders that are willing to give loans startups without collateral, provided that the borrower meet all other requirements. There are several benefits to working with an online lender. The process is quick, easy, and can be done online from your home or office. Many online lenders also have more lenient requirements than banks and other traditional lenders. One thing to note, however, is that most online lenders do require you to sign a personal guarantee before you’re funded.
Take Out A Personal Loan For Business
If you have a good credit score and enough annual revenue, you may qualify for a personal loan that can be used for business purposes. Depending on how strong your application is, you may qualify for lower rates and longer terms than small business loans. You can apply for personal loans through an online lender, bank, credit union, or other financial institution.
Have a new product idea or an interesting business that you’re ready to launch? If so, crowdfunding may be the answer to your capital problems. When launching a crowdfunding campaign online, it is your job to convince others to give money to fund your startup. You do not need collateral, but in some cases, you may want to offer a perk to get people to donate. For example, if you’re launching a new product, you could offer first dibs or a steep discount to someone that donates. In other instances, you may work with fewer lenders and offer equity in your business in exchange for funding. Crowdfunding doesn’t have many of the hassles of traditional lending, but you do have to put in more work to get funding, such as sharing your campaign on social media.
Community development financial institutions (CDFIs) are private lenders that provide funding and other resources for community development. These lenders work with borrowers that may not qualify for funding elsewhere. This includes minorities, women, and startups. CDFIs can provide affordable, long-term finance options for startups, but this isn’t the right option if you’re looking for fast funding, as the application process can be quite lengthy.
Friends & Family
Maybe you didn’t realize it, but you may already know a lender that’s willing to take a chance on you. You can ask a friend or family member for a loan or even an investment in exchange for equity in your business. Even though you know this lender personally, it’s important to keep everything professional. Make sure that you approach the friend or family member as you would any other lender. Don’t forget to make sure that all contracts are drawn up and signed to legalize the transaction. Most importantly, don’t fail to meet your end of the bargain. Plenty of good relationships have gone south due to a business deal gone bad.
How To Improve Your Chances Of Being Approved
Qualifying for a business loan for your startup can be difficult even with collateral. But taking collateral out of the equation entirely may make it seem nearly impossible to get funded.
It is possible to get funded, however. But it can be a challenge. If you plan on applying for a loan sans collateral, you have to make sure that you provide the lender with a strong loan application to show why they should lend to you.
How do you know if your application is strong enough? Start off by taking a look at the 5 Cs of credit.
- Character:Â Do you responsibly make payments on time? Lenders want to work with low-risk borrowers of high credit. Lenders will learn more about your character by looking at your personal credit profile and references.
- Capacity:Â Will you be able to pay back the loan? Lenders will look at financial documents, annual revenue, and even projected revenue to see if you can financially handle the responsibility of a loan. When evaluating capacity, lenders will also look at your debt-to-income ratio and debt service coverage ratio.
- Capital:Â How much of your own funds will go into your business? Lenders will consider how much capital you’re willing to put into your business. Borrowers that are willing to invest their own funds are seen as less of a risk.
- Conditions:Â Lenders also look at conditions before deciding whether or not to approve your loan. This includes the state of the economy, your industry, your competitors, and current interest rates.
- Collateral: Collateral, of course, is what we’ve been covering in this post. If you lack collateral, you’ll want to bolster the other 4 “Cs” as much as possible.
Before applying for a startup loan, make sure you’ve taken the steps necessary to strengthen your application. Order your free credit report, evaluate it for errors, and dispute any errors that you find. Consider paying off (or at least paying down) current credit cards, loans, and other financial products to lower your DTI. Make sure you have strong, reputable references. Finally, make sure you have all of your documentation ready. This includes financial statements and your business plan.
Final Thoughts On Collateral-less Startup Loans
You don’t have to be intimidated by collateral-less loans, but you do need to be prepared. Knowing what to expect, taking steps to strengthen your application, and being prepared to explore different lenders and funding avenues are key to successfully acquiring a collateral-less startup loan.
The post How To Get A Startup Business Loan If You Canât Put Up Collateral appeared first on Merchant Maverick.