When searching for loans and financing for your small business, it’s important to understand the difference between a secured and an unsecured loan. The type of loan you choose will affect your interest rate, repayment terms, and any claims that a lender might have on your small business or personal assets.
Every small business needs access to responsible financing, so we’ll break down the differences between secured and unsecured business loans, and what that means to you.
Small Business Lenders Want to Reduce Their Financial Risk
Before we get into whether a secured or unsecured loan is best for your small business, it’s worth exploring how lenders view small business borrowers. Providing loans to small businesses is essentially about risk management—if a loan provider lends money, how likely are they to get paid back?
It’s inevitable that a percentage of small businesses will fault and default on their loans, meaning that a lender will not have a loan paid back. To hedge against this loss, many small business lenders insist on securing loans with collateral. Even “unsecured” loans often need to be backed up by a “lien” or “personal guarantee.” We’ll get into these terms below, but essentially they mean that if you fail to repay your loan, a lender is legally entitled to seize and sell assets to recover their money.
Differences in Interest and Terms for Secured vs. Unsecured Small Business Loans
Small business lenders also manage financial risk by charging interest across their entire loan portfolio. Small business lending is often inherently riskier than other types of loans, so interest rates are usually higher. Interest rates and other loan terms vary between different types of loans:
- Secured small business loans are backed up by specific collateral and assets, so the interest rates and terms are likely to be more favorable for a borrower.
- Unsecured small business loans have different restrictions and are higher risk, so interest rates will be higher and other terms may be more challenging.
This means you’ll typically repay more if you take out an unsecured loan, and less if you take out a secured one.
Small Business Secured Loans and Collateral
If you want to take out a secured loan, a small business lender will secure your borrowing against collateral owned by your business.
- Collateral can be anything your business owns that has a dollar value.
- This can include property, equipment, inventory, accounts receivable, business bank accounts, and any other assets that could be sold or claimed.
- The type and amount of small business collateral you use to secure a loan will be clearly defined in your loan agreement.
- If you fail to make repayments over an extended period of time and default on your small business loan, a lender has the legal right to seize and sell the collateral to minimize their losses.
The Pros and Cons of a Secured Small Business Loan
Here are the advantages and disadvantages of securing your small business loan.
- Your business will typically pay a lower interest rate on a secured loan and will generally get more favorable terms.
- Your small business may be able to borrow larger amounts with a secured loan.
- The lender will clearly define any small business assets that will be liable to seizure if you default.
- The lender will not be able to seize any assets not defined as collateral in your loan agreement.
- Secured loans are easier for small businesses to get than unsecured ones.
- Not every small business has defined collateral they can put up against a loan.
- The assets you put up as collateral are at risk if you fail to repay.
Not all small business loans require collateral.
Small Business Unsecured Loans
Many assume that unsecured loans are the opposite of secured loans, but that’s not always the case. Although it is possible to find loans that are truly unsecured, they tend to be for lower amounts, charge higher interest rates, and require you to have an excellent personal credit history and supporting business documents.
Instead, lenders will ask for either a “blanket lien” or a “personal guarantee” against your small business unsecured loan. Liens and guarantees are another way to “secure” your loan without needing to clearly define and provide small business collateral.
Small Business Unsecured Loans: The Blanket Lien
A “blanket lien” means a lender can lay claim to any or all of your small business assets if you default on your loan. With a blanket lien, you don’t need to define your collateral upfront, but all of your property, accounts, inventory, equipment, and other assets are liable to be seized and sold up to the total value of your loan.
Small Business Unsecured Loans: The Personal Guarantee
A “personal guarantee” means that you put up your personal assets against a small business loan. This means a lender can use your personal bank account, finances, property, and other assets to pay off a small business loan. If you provide a personal guarantee, the liability protection offered by corporations and limited liability companies will not apply to the loan.
The Pros and Cons of an Unsecured Business Loan
Here are the advantages and disadvantages of taking out an unsecured small business loan.
- You do not need to provide specific collateral against a small business loan.
- Unsecured loans may be available to small business borrowers that would not qualify for a secured loan.
- Your business will normally pay a higher interest rate on an unsecured loan and may get less favorable terms.
- Your small business may not be able to borrow as much.
- Unsecured loans typically require more paperwork and a better personal credit history than secured loans.
- With a blanket lien, any of the assets in your small business may be at risk if you default on the loan.
- With a personal guarantee, any of your personal assets may be at risk if you default on the loan.
Read Your Loan Terms Carefully
Before formalizing an agreement with a small business lender, go through their documentation in detail. Understand exactly what the terms are and what may be at risk if you cannot repay. If you need help understanding your small business loan terms, we have a guide that can help.
Here at Connect2Capital, we only work with responsible small business lenders to provide you with financing. Our lenders provide a variety of secured and unsecured loans at reasonable terms, so you can find the perfect lender for your financial needs.