Many entrepreneurs and small business owners set out to create a great product or service, and deliver it to their customers. Along the way, however, many get sidetracked, with a host of things to do and figure out in order to turn their business into a success. One stumbling block that trips up even the most diligent entrepreneur is securing sufficient funding for purchases, equipment, personnel, and operations. Venture capital is an unreliable gamble, and newer businesses often don’t have the kind of collateral needed to secure bank loans or lines of credit. Fortunately, there is an answer, one that more and more small businesses are turning to for capital: unsecured small business loans from private lenders. These loans have terms of a few years, varying maximum loan amounts, and typically provide business owners with unrestricted cash funds, a fixed interest rate, and monthly repayments. So how do they differ from secured business loans or lines of credit?
Secured vs. Unsecured Loans: A Matter of Collateral and Risk
The biggest decision small business owners need to make when it comes to small business funding is whether they will pursue secured or unsecured loans or credit products. Too often, people construe these terms as having something to do with how safe a loan might be – understandable in this day and age of security breaches and hacking. In reality, however, these terms have everything to do with collateral and risk.
Specifically, secured loans are lower risk for a lender, and higher risk for a borrower. The lender is guaranteed repayment – the loan is “secured” – by the collateral that the borrower must pledge at the time the loan is originated. This reduces risk for the lender, meaning they typically offer a lower interest rate on the loan. However, it increase risk for the borrower significantly. Because of the ways in which collateral are valued, often borrowers will need to pledge assets worth several times the value of the loan or credit product they seek. Additionally, only certain assets qualify as collateral for most institutions offering secured loans and credit products. These factors all add up to make secured funding a risky proposition for small business owners.
By contrast, unsecured small business loans are lower risk for borrowers, and higher risk for lenders. They do not have any collateral requirements associated with them. This means that lenders typically charge a somewhat higher interest rate for these loans. The upside is that there is no collateral risk for small business owners, and no collateral valuation process, either. The end result is a faster loan application and approval process, less risk for business owners, and only marginally most costly debt service expenses.
Banks vs. Private Lenders
When it comes to a source for unsecured small business loans, secured lines of credit, or any other small business funding product, business owners are faced with a simple choice between banks and private lenders. Banks are familiar, known quantities to many small businesses, and a natural first choice. However, what many small business owners don’t know is that most banks don’t like to offer small business loans. They see small business lending as extremely risky, and therefore only want to accept the best qualified applicants. As a result, they often only offer secured business loans and credit products, with high credit score, time-in-business, revenue, and related requirements. That effectively places bank loans out of reach of many small businesses.
On the other end of the spectrum are private lenders. These non-bank entities don’t have depositor or investment accounts, and don’t have the same kind of risk management and capital preservation covenants in place that banks must meet. Often, they specialize only in small business funding or some other sector of the funding market, and more attuned to the needs of their client base. Private lenders almost always offer unsecured small business loans and credit products, or both unsecured and secured options. In most cases, due to the unsecured nature of their funding, they allow small business owners to apply, get approved, and get funded, all in a matter of hours to days, rather than the several weeks or even a month or more that it can take when dealing with a bank.
Parting Thoughts
The bottom line is that unsecured small business loans are lower risk for small business owners in need of versatile, flexible funding for their business. They are easier to obtain, often even with bad credit or a thin credit file. They’re faster to obtain, with funding available in days, not weeks. Customer service and the entire lending experience are often easier and more convenient than at banks. Most important of all, if the worst happens, and your business fails, you won’t be out 300-500% of the value of your loan in collateral assets, like your home, car, property, equipment, and so on. For many small business owners, that’s a risk reduction that is well worth a slightly higher interest rate for an unsecured small business loan.
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