What is Collateral and Why It’s Important to Small Business Loans

If you’ve applied for a small business loan before, you’ve likely been asked about collateral.

Collateral is an asset or property of value pledged by a borrower to secure a loan and reduce risk for lenders. In the event of a loan default — i.e. when a borrower stops making required payments on a debt — the lender can seize and liquidate the collateral to recoup the loss. 

Collateral plays a vital role in the lending process, and understanding its importance is crucial for small business owners seeking a loan to grow their company. 

This article will dive into what collateral is, why it's important in obtaining a small business loan, what might qualify as collateral, and how it is used to assess loan applications.

Note: This is not a comprehensive guide to collateral and each institution has different requirements. Please consult a financial professional before taking out any loan. 

What is Collateral?

Collateral refers to an asset or property that is pledged to a lender to secure a loan. 

It serves as a form of security for the lender, assuring that in the event of default on the loan, the lender can take ownership of the collateral to recover their funds. Collateral acts as a safeguard to reduce a lender's risk. In some cases, collateral can result in more favorable loan terms such as a lower interest rate and larger loan amounts.

The Importance of Collateral in Obtaining a Small Business Loan

For small business owners, collateral is crucial in the loan application process. When applying for a small business loan, the lender assesses various factors such as credit history, business revenue, and the overall financial health of the business. 

Collateral acts as a tangible asset that can strengthen your loan application, especially if you have a limited credit history or are operating in a high-risk industry. It demonstrates your commitment to repaying the loan and provides a sense of security to the lender.

Types of Collateral That Might Qualify

Many assets can serve as collateral for a small business loan. Some common examples include:

• Real Estate: Commercial properties and even personal residences can serve as collateral.

• Equipment and Inventory: Machinery, vehicles, inventory, and other business assets can be used as collateral, particularly in industries where specialized equipment is essential.

• Accounts Receivable: If your business has outstanding invoices from customers, these can be used as collateral to secure a loan.

• Cash Savings: Cash deposits in a business bank account may be pledged as collateral.

• Securities: Stocks, bonds, and other investment securities can serve as collateral, though this might be more common for larger loans. Keep in mind that your brokerage firm must allow your securities to be pledged as collateral. 

The Role of Collateral in Loan Application Assessment

When you apply for a small business loan through AltCap or other lending institutions, the evaluation process typically involves a thorough analysis of your business's financial health and potential repayment capacity. Collateral is a critical element of this assessment.

When looking at collateral, lenders will consider:

• Value of Collateral: Lenders assess the value of the collateral offered. Generally, the value should cover a significant portion of the loan amount. Many banks will require that your collateral’s value be at least equal to the value of the loan, however, this ratio varies between organizations. 

• Marketability: Lenders evaluate how easily the collateral can be liquidated in case of default. Easily marketable assets, like real estate, might be preferred.

• Loan Amount: The value of collateral can influence the maximum loan amount you're eligible for.

How AltCap Differs from Other Financial Institutions 

At AltCap, we understand every business is different, and we're committed to providing tailored solutions to help entrepreneurs succeed. 

Part of how we do that is by offering more flexibility in collateral requirements. We recognize not every small business owner possesses substantial collateral assets. That’s why we take a more holistic approach, considering factors beyond traditional collateral. 

We focus on your business's potential, revenue projections, and overall viability, giving you a fair chance to access the funds you need to fuel growth. Our commitment to flexibility reflects our dedication to empowering a diverse array of entrepreneurs on their entrepreneurial journey. Some of our loans — for example, our ARTcap Express loan for artists that are under $10,000 — do not require collateral. 

Remember, each lender has specific criteria for collateral assessment so it's crucial to understand those needs at the onset. 

If you have questions about collateral or a business loan, AltCap is here to help.

Please reach out to us at info@altcap.org or call (833) 549-2890.