Running and growing a business requires investment – both in effort and money. Even if you have enough capital on hand in the early days of your business, there’s a big chance you’ll need more down the road to fund business initiatives like expansion, inventory top-ups, renovations, and product addition, among others.
Asset-based funding is one of the most common funding options that business owners use. The concept is simple. Banks and other alternative lenders put a lien on a specific business asset or personal asset so that the business owner(s) can obtain the financing they need. The asset, or collateral, serves as the security for the loan, so if the borrower fails to make the required payments or defaults, the lender can repossess the asset to use as payment for the loan.
If you’re short on cash for your business, and you have assets to pledge, you can use them to apply for asset lending. Here are four types of assets you can use to secure funding for your business.
Real Estate
Real estate is one of the most viable types of collateral that business owners can pledge to secure a business loan. Properties are deemed high in value because real estate is constantly appreciating. This is advantageous for business owners because they could potentially borrow thousands of dollars and get favorable loan terms considering that properties hold value well.
However, pledging real estate also poses a greater risk for the borrowers, especially if they’re pledging a personal asset like a home. If they default on payments, they could be left homeless as banks would take their house as payment for the loan. Or, if they’re using a property to run their business’ operations, they would lose that property. This is another reason banks look favorably on properties as collateral. Their value to the borrower creates a huge incentive for the borrower to make the necessary repayments.
The risk involved in pledging a property is relative. If you own a property you’re not using, it would still present good value to the lenders but you the borrower knows that you could live without it in the event that it was repossessed.
The type of properties you can use as collateral include:
- Pieces of land
- Buildings
- Houses
Equipment
Equipment as collateral is a viable option for business owners who use heavy equipment and machinery in their day-to-day business operations, like construction or manufacturing companies. There are a few factors that determine the value of the equipment being used as collateral.
If the lenders find that it may be difficult to find buyers for the asset – be it heavy machinery, equipment, a vehicle, etc. – they typically won’t view that specific item as valuable, regardless of its price. Lenders may value vehicles less because their value depreciates with time. The same goes for computers and other electronics used in the business.
If you’re looking for a business loan to purchase equipment, you can apply for equipment financing from banks or alternative lenders. In this arrangement, the lenders will partially or fully finance the equipment, depending on the borrower’s qualifications and creditworthiness.
Inventory
Another common type of collateral used to secure financing is inventory. Inventory loans generally make use of the store or company’s inventory to obtain additional capital for business growth.
The idea behind this arrangement is that retail business owners typically have a lot of inventory stored to keep up with their customers’ demands. If the business’ capital is tied up in those unsold stocks, it will be harder for the owner to fund other business initiatives. By pledging inventory as collateral, lenders can free up cash tied up in the stocks to give you, the borrower, enough capital to finance other business investments.
There is certainly risk with pledging this type of asset. If the borrower defaults on the loan, they will lose their inventory. Without inventory, it will be harder for the business to generate sales and keep its operations thriving in a competitive market.
Invoices
Accounts receivables, or invoices, can also be used to secure financing for your business. Typically, it takes around 30 to 90 days for customers to pay their outstanding invoices, depending on their agreement with the business owner. These unpaid invoices can cause a significant cash flow gap for businesses.
Business owners can free up cash by using their invoices as collateral for a business loan. This is called invoice financing. With invoice financing, the financing companies lend the business owners money upfront in exchange for their outstanding invoices, giving the lenders full control of the business’ invoices. The financing company can also take over the collection of payments from your customers.
After the financing company has collected the invoices, they will deduct the money owed plus interest and other fees associated with the loan. The remaining amount will then be forwarded back to the business.
Lenders can finance around 80% to 95% of the total amount of invoices being financed.
Final Thoughts
Having collateral can increase the chances of loan approval, especially if the borrowing business still hasn’t established a good credit standing or cannot show a strong enough cash flow. However, choosing what collateral to use for your business loan application isn’t always an easy decision. There are a lot of risks involved in pledging assets to secure funding. In cases where you can’t repay the loan, the lenders could take your collateral, and there will be no way of getting it back.
If you don’t have collateral to pledge, you can always go for the unsecured loan options. However, without collateral, lenders face a higher risk for non-repayment. As such, they are more likely to charge borrowers with higher fees and interest rates to mitigate the risk involved.
It’s essential to consider both options when you’re looking to secure funding for your small business. Ultimately, the decision will lie in what option best suits your company’s interest and protects your business’ future.
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