How Much Collateral Do You Need for a Business Loan?

How Much Collateral Do You Need for a Business Loan?

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Business loans are usually secured with collateral, which is an asset pledged to the lender by the borrower for the life of the loan. The collateral can be seized and sold to repay the loan if the borrower defaults. Lenders use collateral to reduce the risk of losing money on the loan. The amount of collateral needed varies widely based on several factors, including the credit rating of the borrower, the reason for the loan, the type of lender, and the nature of the collateral. Some lenders will allow, or require, borrowers to pledge both business and personal assets to secure a business loan.

What is Used as Collateral for a Business Loan?

Collateral is an asset, which is anything of value. But not all assets can function as collateral, and some forms of collateral are favored over others. The best collateral—from the lender’s viewpoint—is an asset that can be quickly liquidated, meaning it can be converted into cash. Topping the list is cash itself, held in demand deposit accounts, followed by negotiable securities—paper assets—like Treasury debt, certificates of deposit (CDs), stocks, and corporate bonds. A lender that seizes paper assets can sell them in the capital markets, on public exchanges or through brokers.

Property that can be used for collateral includes buildings, equipment, fixtures, inventory, homes, and vehicles. These are all tangible hard assets already owned by the business or the business owner. Hard assets require more work to liquidate, and their value is less certain. Because of these additional risks, your lender will discount the value of this collateral to a greater degree than paper assets. In some cases, the hard asset will need to be appraised and its value certified by the lender or a third party.

Another class of collateral is based on future earnings, which include accounts receivable, notes receivable, and invoices you have sent out. These are riskier than hard assets because of the possibility that the earnings won’t be fully collected.

Some business loans require you to pledge personal assets—such as your home or car—in addition to business assets. The Small Business Administration (SBA) may require this if your business doesn’t have enough assets to provide the collateral required. Unsecured loans are also available to some businesses. These are loans that have no collateral requirements. They are based on the creditworthiness of the small business borrower and their business’s net operating income over the last year or two.

How Much Collateral Do Lenders Require?

A basic concept regarding the use of collateral is the loan-to-value ratio. This is the amount a lender will lend to you based upon the value of the collateral. For example, a bank might offer an 80% loan-to-value ratio for a business loan if you pledge real estate as collateral. That means it will lend you $80,000 when the property is worth $100,000. The difference between the collateral’s fair market value and the amount of the loan is called the discount, or haircut. In this example, the haircut is 20%.

Easily liquidated paper assets have a smaller haircut than hard or future assets. Borrowers will never receive loan proceeds equal to 100% of the collateral’s value, because even the most liquid assets can only be seized and sold through a court process that involves delay and expense. Therefore, a borrower must overcollateralize a loan—put up more than 100% collateral—to receive the loan amount requested. Depending on the liquidity of the collateral, loan-to-value ratios will typically range from 50% to 98%, although there are outliers at both ends of the range.

Some lenders will evaluate your credit score in addition to the amount of collateral you can provide. For example, a bank requires a good credit score even if you have plenty of collateral. A hard-money lender, on the other hand, looks at the value of the property serving as collateral, with little regard to your credit score. In general, having collateral helps you get a loan more easily, but it’s not a panacea for a poor credit score.

All collateralized business loans have liens attached. A lien allows lenders to sue a defaulting borrower in court. Liens can be either generalized ones that collateralize all assets of the business—known as blanket liens—or they can be attached to specific assets, such as a building or piece of equipment. Blanket liens are preferred by lenders because multiple assets can be used to satisfy the loan, and these liens might be accompanied by better loan terms and a higher loan-to-value ratio.

Collateral by Type of Business Loan

The table below summarizes collateral according to the type of business loan. The collateral accepted and the loan-to-value ratio permitted will depend on how the loan proceeds will be used.

Loan TypeTypes of CollateralTypical Loan-to-Value Ratio
SBACollateral is typically real estate, but other assets can include undeveloped land, equipment, inventory and accounts receivable. May require owner's home be pledged.
  • Real estate: up to 85% of the property’s current value.
  • Other collateral types: 20% - 50%
General purposeMight require no collateral (unsecured loan). Otherwise, most types of collateral are acceptable.
  • Future-earnings: 20%
  • Negotiable securities: Up to 95%
  • Cash: Up to 98%
Commercial real estateThe property being purchased, developed or remodeled.
  • Hard-money loans: 65% to 75% of the property's final value.
  • Bank loans: Up to 80%
  • SBA loans: Up to 90%
EquipmentThe equipment serves as its own collateral.50% - 60%
InventoryThe inventory serves as its own collateral.Up to 50%
Accounts receivable and invoice financingFuture earnings serve as collateral.Up to 80% (based on your customer’s creditworthiness)
Peer-to-peerTypically, these loans are unsecured.N/A

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Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.