What is an unsecured business loan?
Convincing a lender to fund your business investment can be difficult. Most of the time, they want to see proof of a successful history and a strong, steady income. Without it, you are a much riskier applicant.
Lenders sometimes require collateral to reduce the risk of a loan transaction. This means that if you default, they can seize the collateral – whether it’s a bank account, business inventory, real estate, etc. – to cover losses.
But with an unsecured business loan, you can get financing that doesn’t require collateral. Keep in mind, however, that because there are no commercial asset-backed loans, lenders typically have stricter eligibility requirements and will impose personal guarantees.
How does a business loan without collateral work?
Commercial loans without collateral help companies make large purchases and cover operating costs. The funds are usually paid in a lump sum and can be used to make specific purchases or manage cash flow, and then repaid with interest. However, there are other types of small business loans – such as lines of credit, merchant cash advances and invoice financing – that can be used to get cash as needed more quickly.
Personal Collateral Requirements
If you are applying for a business loan with no collateral, you will usually need to sign a personal guarantee for the loan. This is not quite the same as pledging property to obtain a secured loan, but if you default, the lender can go after your personal assets to pay you back what you owe.
Starting a business loan option without collateral
If you’re starting a new business from scratch, you may need a large sum of money. Here are some options for an unsecured business loan.
SBA Loans under $25,000
If you only need a small amount of start-up capital and are not in a hurry, a loan under $25,000 from the U.S. Small Business Administration (SBA) may be a viable option.
These types of loans typically offer the most business-friendly terms and lower interest rates compared to other loan options. This is because they are partially guaranteed by the SBA, so if you default, the lender may be able to recover some of its losses directly from the government.
SBA loans come in all shapes and sizes. For larger loans, collateral is usually required. However, if you apply for a standard SBA 7(a) business loan, you may not be required to provide collateral for loan amounts less than $25,000. However, you and any other owners who own at least 20% of the business will need to personally guarantee the loan. This means you legally agree to repay your personal assets borrowed if the business fails to do so.
Start-up Loans Online
Traditional financial institutions may not be as friendly to startups, but that doesn’t mean other lenders won’t be. It’s relatively easy to find loans specifically for new startups, often from smaller online lenders. As with other forms of alternative small business financing, online start-up loans tend to be more expensive, so you’ll need to consider this carefully in your business plan.
Merchant Cash Advances
When you use a merchant cash advance (MCA), you receive a one-time payment, just like a loan.
However, instead of paying back the loan in a steady manner over time, you pay interest, and you agree to a factor rate to set the total amount you pay up front for the loan. You then pay it back as a percentage of the credit card transaction – this is known as the retention percentage. These payments are usually more frequent than typical loans – sometimes even daily – and you will continue to make payments until your advance is fully repaid.
For example, if you borrow $10,000 at a factor of 1.25, you will pay back a total of $12,500 to the lender ($10,000 x 1.25). If you agree to a 10% retention percentage, you will pay the lender 10% of all daily sales until you repay the full amount (the $10,000 you borrowed, plus a $2,500 finance charge).
Because your payments are based on your sales, this is a particularly good option for businesses with seasonally fluctuating revenues or for new startups that can’t commit to paying a certain amount each month. However, without a defined term length, you can’t easily calculate an equivalent annual percentage rate (APR) and compare it to other loan options. However, they are usually more expensive than standard business loans.
Alternatives to unsecured business loans
Many businesses need multiple sources of financial support to get started. You may need to pull together several types of start-up capital. Here are some other ideas.
Equipment Financing
Equipment financing works in a similar way to auto financing. When you apply for an auto loan, it is secured by the car you purchase, which means you don’t need to have collateral on hand before you can get a loan. Similarly, many small business lenders offer secured loans in the form of equipment financing, where the equipment you purchase serves as collateral for the loan.
While this type of loan may not necessarily address your need for a storefront, business inventory or labor, it may be a good option if you need equipment to get started.
Crowdfunding
If you have a strong social network, another option to consider is crowdsourcing to raise the capital you need to launch your business. This is obviously not for everyone; for example, you wouldn’t expect to start a new biomedical company by setting up a fundraising campaign on Kickstarter. However, if your business is relatively small, this may be a good option.
Personal savings
Many people also use their personal savings to help start a business. It may be tempting to tap into your emergency and/or retirement savings, as these may be the largest buckets available to you; however, think carefully before you do. Make sure you have a plan for what to do if you lose that money.
It’s also a good idea to work with an experienced small business accountant who can help advise you on the most tax-efficient business setup and how to write off your personal investments in your business.
