What You Can Use for Collateral on Business Loans

Posted at 13:58h in Small Business Financing by Kelly Hillock

Most business loans require the borrower to put collateral down on a loan as a way to recover their losses in case of default. Collateral refers to assets the borrower owns which are listed on the loan agreement as assets that can be seized in case of default. The collateral can be listed on the agreement with generic terms or specific items.

A blanket lien will be generic and say “vehicles”, “real estate”, or “stocks and bonds” which allows the lender to access virtually anything the borrower owns and fits these descriptions.

Specific UCC filings will have addresses instead of the words “real estate” or specific stocks and bonds vs. generic wording. This protects the borrower from losing all assets if they default as the lender can only seize and sell what is specified on the filing.

Borrowers can only use assets they fully own as collateral. The exception is when the loan itself is used to purchase the asset — in that case, that asset usually becomes the collateral.

Inventory financing will list the SKUs and specific types of inventory the borrower is buying or manufacturing. Meanwhile, renovation financing may list the property (if owned) or the furniture and equipment that was upgraded in the space. When collateral is required, the loan is called a secured loan because the collateral secures the loan against default. Unsecured or no collateral loans are when no collateral is required, but these are very rare and hard to get approved for. In most cases, the borrower needs to have a long-standing relationship with the lender, strong financials, and a proven track record to qualify for unsecured loans.

Curious about what can and cannot be used, or if you can change assets out half-way through the loan? Keep reading and we’ll answer the questions most business owners tend to have about collateral on business loans based on our experience financing businesses like yours.

Assets That Can Be Used as Collateral on Business Loans

Assets that can be used as collateral on a business loan include anything that the borrower owns in full, that will be easy to sell for cash, and that likely will not lose its value or depreciate too much during the length of the loan.

Assets that can be used as collateral may include:

Stocks, bonds, and investments

Machinery, equipment, and vehicles

Real estate

Inventory

Business investments and savings accounts

Office supplies, furniture, and assets like computers or servers

The lender is looking to protect their losses if you default on your business loan, so any item that is easily turned into cash and keeps or increases in value can be used. If your company is new or you don’t have enough assets the lender will accept, they may ask for a personal guarantee on top of collateral.

Pro-tip: If you offer a larger deposit or are able to reduce your risk as a borrower by cutting expenses to have better financials, you may be able to reduce the amount of collateral needed.

Personal Guarantee vs. Collateral

A personal guarantee is a commitment from the borrower to use personal assets to repay the loan if the business defaults. Just like business collateral, the owner or owners must own the assets in full and the personal guarantee can be “limited” or “unlimited”.

Limited guarantees allow the lender to seize up to a certain limit, and unlimited guarantees allow them access to everything listed on the loan agreement. Just like the UCC filing, the borrower should be as specific as possible. List street addresses rather than saying “real estate” so the lender can only go after a vacation home or rental unit and not a primary residence.

Although a borrower cannot sell, upgrade, or modify assets used as collateral without the lender’s permission or an agreement made on the loan contract, borrowers do have rights.

When Borrowers Can Renegotiate Collateral

Borrowers have some flexibility on the collateral they use for a business loan when it comes to selling, upgrading, or replacing the assets used. In an ideal situation, the borrower will know if they need to upgrade or replace the asset before signing, and they’ll be able to add that ability to modify collateral to the terms of the loan.

One example is when the borrower uses a truck for collateral but plans on buying the new model that will come out in 6 months. The borrower can have a clause that allows them to sell the original truck if they purchase the new one, so long as the new model replaces the old one on the UCC filing.

Then there are situations that cannot be predicted, but that will benefit the borrower and lender, like a large client coming as a referral and requiring upgraded or larger manufacturing equipment. By being able to meet the new client’s demand needs, the borrower becomes more profitable and can pay the loan back more easily, so the lender benefits as well. In these cases, because it is an unexpected event, there likely wasn’t an allowance in the existing loan agreement, but the borrower can bring the new client’s contract to the lender to see if they can amend the loan agreement to both their benefit.

The amendment can let the borrower sell the old equipment and replace it for the new equipment, while placing the new equipment as collateral. If the borrower needs more money for the equipment, they may be able to roll the current loan into a new one (i.e., equipment financing) and have the new equipment placed on a new UCC filing. It’s a win-win for everyone: The borrower gets the new client and the lender gets a longer term and larger loan with more interest payments.

A somewhat common situation that occurs is where a borrower wants to sell an asset used as collateral because it is no longer needed, so they won’t be replacing it. Instead of adding new physical assets, they offer bonds or investments that can appreciate in value or use them to pay the balance of the loan. In these cases, lenders may accept these assets to pay off the balance or hold the assets because the lender may make more by owning them in a default situation.

Collateral is almost always required with a business loan, so don’t stress if a lender asks. It does not mean the financing is getting rejected or that there is a problem with your business credit score. You should be able to negotiate some of the assets used, and make sure the UCC filing has specific assets listed versus being a blanket lien.

QuickBridge does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.