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How to Use Collateral Correctly for a Business Loan

How to Use Collateral Correctly for a Business LoanWhen your small business is just about to take off and only needs a boost of cash, it is worthwhile considering a business loan. On other occasions, you may need a cash influx to keep your operations going, until you start getting payments from your customers. At any rate, if you need to look for outside sources of financing, you should strive to take them on behalf of your business, and not yourself as an individual.

The Advantage of Business Loans over Personal Loans

On many occasions, we have advised our readers to be careful about separating their personal assets from the assets they endow their business with. Should your business get sued by a customer or a supplier, your personal assets will be safe from seizure.

The same thing goes for bank loans. If you default on payments, the bank will go for the assets belonging to your business. At the same time, if you keep up with your payments, your business entity will have a higher credit score and, in the future, you will be able to negotiate better terms for loans or lines of credit.

However, since your business is at the start of its existence, it probably has little or zero credit history and banks will ask for collateral to secure a loan from them. It is important to know exactly what you can (and should) offer as collateral and all the potential scenarios which may happen if you cannot pay your loan on time. Here are a few key considerations.

1. Know What You Can Use as Collateral
Before you apply for a business loan, you should know what types of assets banks accept as collateral. Since the real estate bubble, homes have suffered a huge drop in value as security for loans. Vacant land (agricultural or otherwise) is not even considered as a viable asset for business loans by most banks, because these are the most difficult to capitalize on.

In general, any item with a transferable title such as cars, IT and industrial equipment, and other machines and gadgets can be used as collateral. Items which you made on your own, such as products you manufacture for your business or other artisanal products and machinery are quite tricky – you do not hold a clear title on them and your appraisal may vary wildly from the bank valuator’s opinion.

2. Keep a Detailed Record of Your Assets
When you approach a bank to negotiate a business loan, always bring a clear and detailed record of the assets you own: real property, business inventory, accounts receivable, and cash deposits and savings.

By having this list prepared, you save yourself time and show the bank that you are a savvy business owner and you have a clear idea of the proof you are expected to bring to show that you are in good standing.

3. Do Not Guess, Know What Your Assets Are Worth
The next step after you identify all your assets is to appraise them. Movable assets are easier to appraise (stocks, bonds, savings and checking accounts) than immovable ones. Cars, motorbikes, computers and other office equipment must be appraised in accordance to their age – the older they are the more their value decreases.

When in doubt, go to online stores for pre-owned vehicles and IT equipment and look at the asking prices for items similar to yours (attention: the asking price varies usually from the actual sale price).

4. Discuss Various Scenarios with the Bank Representative
Before you sign above the dotted line, know exactly what you are in for. Ask the bank representative to present in layman terms all conditions of the loan, what happens if you are overdue with one of the payments, whether you benefit from a grace period, and so on.

The representative is obliged to give you all this information before you sign the agreement and to disclose all the bank’s policies for going after defaulting customers.

5. When in Doubt, Consult with a Financial Adviser
If you want to be certain that you hold all the facts and potential effects on your business and personal assets, go to a financial consultant and disclose the entire situation of your financial standing, the assets you wish to use as collateral and the conditions of a business loan.

And, just as important, discuss with your family, explain all the potential outcomes of taking a business loan on their lives and listen to their objections and advice before making any decision which may impact everyone’s lives.

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