You may be facing a choice between applying for an unsecured working capital loan or a conventional bank loan, and weighing the pros and cons. If so, then one of the key aspects you definitely want to analyze is collateral.
Why Banks Demand Collateral
As you may know, banks offset the risk of lending onto borrowers by demanding that they collateralize the loan with assets such as property, vehicles, equipment, securities and so on.
However, an extremely important point that some business owners aren’t aware of when they apply for a collateralized small business loan from their bank, is that they might not see eye-to-eye on certain aspects. Specifically, there are 3 common stumbling blocks that many business owners trip over -- and often through no fault of their own:
If you’ve ever shopped for a home, a used car (or even sometimes a new one!), or any other “big ticket” item, you’re aware that prices can vary; and often considerably. Well, when it comes to the value of your assets, your bank may determine that they’re worth considerably less than you think they are. In fact, you should count on this, as banks are notoriously conservative when it comes to evaluating collateral.
For example, you may consult a credible industry expert who tells you that your 2-year old industrial equipment (which you own) is worth $150,000, and depreciates in value at a rate of 15% each year. But your bank’s expert may say that it’s worth $100,000, and depreciates in value at a rate of 25% per year. Guess what? Your bank will defer to their in-house expert -- not yours. This would mean that you need to put up even more collateral to secure your loan.
You may think that your vehicles, properties, equipment and so on will serve as sufficient collateral for your business loan. But that doesn’t necessarily mean that your bank will agree. If they don’t, then you simply won’t be able to use it as collateral, and will have to use other assets.
A theme that you’ve probably picked up on here is that banks hold all the cards when it comes to handing out loans to small and mid-sized business owners, for the simple fact that they are not motivated to make these loans in the first place.
As such, small and mid-sized business owners like you have virtually no leverage to negotiate better terms or valuations of their proposed collateral. If you don’t like what your bank is demanding, then there’s no appeals process, no independent arbitrator, no complaints department, and no remedy other than to close your account and take your business elsewhere.
Unsecured Working Capital Loans: No Collateral Required
Clear across the other end of the spectrum are unsecured working capital loans, which don’t require collateral of any kind. Why? Because lenders that offer unsecured working capital loans understand that in a real partnership, risk is something that all parties share.
So, if you’re considering applying for a conventional bank loan, make sure you give careful consideration to the implications and consequences of providing collateral. After you’ve analyzed the costs and risks, you may realize that an unsecured working capital loan is indeed the superior option.
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