What is Business Collateral?
If you are a small business owner, securing a loan might be one of the options you are considering when it comes to financing your business’ operation and expansion.
However, securing a loan is not always an easy and quick process.
There are requisites needed before a loan gets approved and one of those requisites is known as collateral.
What is collateral?
A collateral is any kind of asset that a borrower offers as a security to a loan.
A loan agreement backed by a collateral is referred to as a secured business loan.
Generally speaking, a secured business loan offers a lower interest rate compared to an unsecured loan.
Collateral also acts as a form of protection to the lender if the borrower defaults on the scheduled loan payments.
In the case of a borrower defaulting, the borrower could lose the asset pledged as collateral which lessens the likelihood of a borrower failing to meet their financial obligation.
The lender has a legal right to take the asset used as collateral in order to recover from the losses they may sustain in the event that the borrower does not have the means to continuously pay for the loan they have managed to secure.
The claim over the collateralized asset is called a lien which is created when an asset is registered as collateral.
The right to claim will only take effect when the lender has proof that the borrowers have been delinquent.
On the other hand, loans that carry a higher interest rate are called unsecured loans.
An example of an unsecured loan is a business credit card.
In securing a loan, a collateral can come in many forms, however, having no collateral at all when applying for a loan agreement is uncommon.
Despite this, there are some cases when a collateral is unnecessary.
A collateral with a monetary equivalent such as a business’ assets tend to not be needed when a borrower’s overall credit standing and financial capacity are enough to function as a security and can guarantee the repayment of a loan.
Examples of the different kinds of collateral
When a business loan is approved, the borrower can use any kind of asset as collateral – whether it is a tangible or intangible asset – provided that it can actually suffice in value to secure the loan.
To give an overview of the different kinds of collateral that can be used, you may refer to the table below:
|Tangible Assets||Intangible Assets|
|Vehicles||Small business trademarks|
While both tangible and intangible assets have their respective monetary values, the difference between these two kinds of assets lies in how they are used by the company.
Tangible assets are physical items mainly used to produce the company’s products or services while intangible assets are incorporeal items that cannot be seen nor touched but have a stored value that can be amortized in the future.
It is common also for a business to use its accounts receivable as a collateral in securing a loan to represent the amount of money owed to the business which the lender can have rights to if the business defaults in payments.
What is the purpose of having a collateral?
As a business owner, knowing the purpose of a collateral is a must.
Below are some common reasons why lenders require collateral assets:
Since the primary security in a loan agreement is the borrower’s affixed signature, the lender may require secondary security in case the borrower fails to repay the specified loan amount.
The collateral will serve as a secondary security, insurance to the lender, an incentive to the borrower to meet the payment due, and helps to get the application approved.
Take note: the signature states the borrower’s financial obligation to pay a specific amount at regular intervals until the full loan value and interest is paid.
Fair market value
To put it simply, the fair market value is the price of an asset’s worth in regards to its current market value.
The fair market value is the price that both the seller and the buyer can agree on though there are times when the fair market value can also be an amount comparable to the prices other parties have paid under similar circumstances.
The fair market value is typically higher than the loan amount in place of the anticipated additional costs and expenses that would be incurred.
This addendum includes transportation, liquidation delay, or sale fees.
Do not get confused if the fair market value gets interchanged with another term known as the book value.
The fair market value and the book value are separate items that you will need to take note of when dealing with the finances of your business.
The book value is the value of an item listed on the business’ books while the fair market value is the sale price of an asset based on how much it would actually sell for in the condition it is in during a certain moment in time, thus its actual price can fluctuate depending on how in demand that asset is in the market as of the date the business is planning to put it up for sale.
Some tips for getting business collateral loans
A collateral is only one of the deciding factors that helps a business in getting an approved loan application.
There are other factors that will still need to be considered. Here are some tips that you can use to get a business collateral loan offered to you:
- For small business loans – you are more likely to get a business collateral loan approved when your equity investment and management expertise are in good shape.
- For all other business sizes – you are more likely to get a business collateral loan approved when your company has a healthy financial ratio, acceptable company credit standing, and complete financial statements.
The main piece of advice here is to always show the lender that your firm can afford to pay off the loaned amount by having your financial statements prove the health of your company along with the assets that can back you up to better your chances in getting a business loan.
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IRS.gov "Collateral Agreements and Security Type Collateral" Page 1 . August 30, 2021
SBA.gov "Collateral and Credit" Page 1 . August 30, 2021