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Intelligent Financing is Your Competitive Edge

Special Report
February 2019

Unsecured Business Loans

If you’re a small business owner, you may have looked into a small business loan as a source of financing. Small business loans typically are used to start or expand a business, purchase inventory and supplies, or strengthen a business’s solvency. In fact, 69 percent of small firms used some form of financing, according to the National Small Business Association.

However, traditional lenders, such as banks, typically require small business owners to offer some form of collateral for a business loan. Collateral can be business or personal related and include real estate, an auto title, equipment, savings and other assets.

The median small business has less than a month's worth of cash available to pay expenses if there were to be a gap in the company’s cash flow, according to a 2016 JP Morgan Chase & Co. Institute study. Many small businesses don't have collateral to pledge for a loan, or would have to resort to pledging personal assets like their home equity for collateral.

Unsecured loans from alternative lenders may be a good choice for small businesses that don’t have collateral or well-established credit ratings.

“An unsecured loan can provide essential financing for a business that is facing a crisis or an opportunity,” says Gerri Detweiler, education director for Nav, which offers free personal and business credit scores and a small business financing marketplace.

Small business loans can be difficult to obtain without collateral, but options do exist. This guide will help you explore those options and find the best loan to start or grow your small business.

You’ll learn about the different types of unsecured financing for small businesses, how to apply for an unsecured small business loan, and how to choose the best unsecured business loan for your company’s needs.

How Unsecured Business Loans Work

Traditional small business lenders typically require some form of collateral before approving a loan. Collateral is a valuable asset that the borrower offers as security for the repayment of the loan. If the borrower defaults on the payments, the lender can claim the collateral.

If your business has valuable assets such as inventory, furniture, real estate, vehicles, even computer code, you might be able to use them as collateral for the loan. But if you don’t have any business assets, lenders may approve a loan with the expectation that you offer personal assets as collateral, such as your family home or a vehicle.
Not every borrower is in a position to put up collateral for a small business loan. The good news is there are a number of alternative lenders that not only make small business loans to those who would usually be denied by traditional banks, but also offer unsecured loans that require no collateral.

Advantages of Unsecured Business Loans

Easy to obtain: Unsecured business loans are easier to obtain than secured business loans because your business doesn't need to supply collateral. They typically offer a faster, simpler process for the small business owner and financial institution to work through the application and funding process.

“It's similar to the difference between applying for a credit card, which is unsecured and usually provides immediate access to credit, and a vehicle loan or a mortgage, where a financial institution takes a lien on the vehicle or the house as collateral,” says Mark Mitchell, head of small business distribution strategy at TD Bank.

Faster approval turnaround: Unsecured business loans usually have faster approval times. Online applications aren’t nearly as lengthy as a typical loan application. Some lenders approve unsecured business loan applications in as little as 24 hours. Other forms of financing, such as a secured business loan or SBA-guaranteed loan, can take a month or longer to be approved.

Higher loan amounts: Small businesses may be approved for a higher loan amount. Because there are no collateral requirements limiting the value of the loan, the amounts can potentially be higher, points out Bill Burnham, a Florida Small Business Development Center (FSBDC) consultant at the University of South Florida.

Typically, with secured loans, you can’t borrow more than the value of your collateral. In fact, lenders normally extend up to a certain percentage of how much your collateral is worth. This value of your loan against the value of the personal or business property you are providing as collateral is called the loan-to-value ratio.

Fewer restrictions on use of funds: Unsecured business loans typically don’t have many restrictions, aside from not using the financing for illegal activities, gambling or buying securities.

Lenders can’t take your business property: While lenders can seize collateral if your business defaults on a secured loan, a lender can't take your business or personal property if you default on an unsecured business loan without a court order.

Unsecured loans may be discharged in bankruptcy: If your business files for bankruptcy, the court may discharge unsecured loans. Secured loans are typically not discharged.

 Disadvantages of Unsecured Business Loans

Personal guarantees are required: With a secured business loan, the lender can only take the collateralized asset as collateral. With an unsecured business loan, the borrower typically signs a personal guarantee. While you don’t need to provide a specific asset when you sign up for the loan, even if you sell or dissolve your business, you are still personally liable for the loan and need to pay back the loan. With a personal guarantee, a lender has a greater ability to pursue any assets you personally own – now or in the future.

Higher interest rates: Unsecured business loans are riskier for lenders, so interest rates on unsecured business loans are often higher than on secured business loans, Burnham says.

“The business owner needs to be aware of the APRs on these loans, which can exceed 100 percent,” says Burnham. Your business will pay more over the life of an unsecured loan than a secured loan of the same amount.

Shorter repayment terms: Unsecured business loan repayment terms are usually shorter than those of secured business loans, which means the borrower will need to be prepared to pay off the loan quickly. Plus, the lender may require more frequent payments. “Some lenders require payments on a weekly basis, which may cause a cash crunch for the unprepared business owner,” says Burnham.

Qualification requirements: Unsecured business loans can be harder to qualify for. If your business has a poor or nonexistent credit history, the lender may not approve your application. You may be required to provide both personal and business credit history.

Conversely, some lenders don’t weigh your credit as heavily and look primarily at your business’s revenue, explains Detweiler. For example, a business with strong credit card sales, or sales via Paypal or Amazon, may be able to get an advance on those funds, and the decision will largely be based on those revenues.

While there are drawbacks to unsecured business loans, particularly that they can be more expensive, unsecured business loans aren’t necessarily a bad thing, Detweiler says. “If you need money fast to take advantage of a great opportunity, then it can make sense,” she says. “Or if you have a crisis that can be overcome – not made worse – by a short-term loan, it makes sense.”

Types of Unsecured Small Business Financing

Unsecured small business loans work just like traditional small business loans, except that you aren’t required to offer a form of collateral. Alternative lenders are usually a better option than turning to credit card debt, and can offer more favorable rates and less red tape than a commercial lender, explains Phillip Russo, a business consultant with the Louisiana Small Business Development Center at the University of Louisiana at Lafayette.

“The application process is usually easy, fast, and does not impact your credit score,” says Russo. “Typically, the loans are unsecured and can accommodate small startup expenditures and working capital.”

Types of unsecured small business loans typically offered by alternative lenders include:

Term loans: Term loans provide small businesses with a lump sum of capital. Businesses agree to pay back the term loan over a set amount of time with an agreed upon payment schedule. Each payment includes the principal amount, plus the interest you owe on the loan for that period. While these loans are typically easy to secure, term loans with short repayment periods can be challenging for a small business or startup due to larger payments.

Business lines of credit: With a business line of credit, a lender approves you for a revolving line of credit. It works in the same way that credit cards do; there’s a maximum limit you can borrow and you’ll be charged interest only for the amount of money you borrow.

You can rely on your line of credit for business-related expenses, such as purchasing inventory, investing in marketing, filling in cash flow gaps, or growing your business. As long as you make the minimum payments and don’t go over your cap, you’ll have access to your business line of credit for as long as you need it. For instance, let’s say you have a $10,000 business line of credit and you spend $5,000. You’ll still have $5,000 available, and once you pay $5,000 back to your lender, you’ll be back to the original amount.

Business lines of credit can be secured or unsecured. This form of financing can provide flexibility for paying business expenses, but unsecured lines of credit can be challenging to secure from a bank, explains Russo. “Banks typically want collateral to secure the amount requested, and they are easy for business owners to deplete if business is not sustainable,” he says. In turn, this will be more challenging if the business fails in paying back the line of credit.

Riskier Unsecured Financing Options

Invoice financing: Also known as invoice factoring, invoicing financing is a option for small businesses struggling with cash flow issues, specifically due to unpaid invoices. With invoice financing, you sell your unpaid invoices to a lender at a discount. In return, the lender offers most of the amount owed on these invoices upfront. The lender will keep part of the outstanding amount (typically 20 percent) until the invoice is paid off. The borrower will receive the remaining amount once it’s paid off.

Invoice financing can be risky and expensive. While invoice financing is easy to secure, Russo points out that the lender will take a portion of the amount, which could be hefty. Plus, the fees can quickly add up. There’s typically a factoring fee based on a percentage of the invoice, plus a cash advance interest charge. Small business owners should carefully consider the costs when it comes to invoice financing.

Merchant cash advances: A merchant cash advance, or MCA, is a financing option for those who are seeking quick access to capital. The lender provides a single sum of cash for a percentage of your forecasted sales.

You will repay the advance, plus any fees, with either a portion of your future credit and debit card sales or fixed daily or weekly transfers from your bank account. Your fees are determined after assessing your risk. Borrowers perceived to be a lower risk will net more favorable borrowing terms and lower fees.

Borrowers should beware of the long-term financial implications of MCAs. Because they normally have high interest rates that can hit triple digits, they are often not a sound choice for businesses.

Choosing the Best Unsecured Business Loan

When choosing an unsecured loan for your small business, you should pay attention to the lender’s eligibility requirements, loan options, costs and reputation. Keeping these factors top of mind will help you increase your odds of finding an alternative lender that will approve your loan, and offer you solid customer service, support and the best terms possible with reasonable fees.

Eligibility Requirements

It’s important to find a lender that is a good fit with your eligibility. Otherwise, you may waste time and money applying with lenders you don’t qualify to receive financing from.

• Minimum personal and business credit score: Lenders may review one or the other, or both, and sometimes it's hard to know which will be most important, explains Detweiler. To be safe, get a credit report for both your personal and business credit score, and scan it for errors. Depending on what the errors are, they could hurt your credit score. You’ll want to dispute these errors before you apply for financing, and take steps to improve your credit score.
• Minimum years in business: Most unsecured business lenders don’t work with startups. They typically require a minimum of three months to two years in business, usually at least one year.
• Minimum annual revenue: Some lenders extend financing to startups with no minimum revenue. If that’s the case, other factors may be weighed more heavily, such as creditworthiness and projected revenue.

Loan Options

Loan types: Narrow your search to lenders that offer the type of loan you’re seeking, whether that’s a term loan, business line of credit or equipment loan. Create a detailed, thorough business plan and focus on the type of funding and amount you need, and be prepared to answer lender questions, points out Burnham.

“As with any loan, accuracy in supplying the requested information will assure a quicker turnaround through the application process,” says Burnham. “An applicant should be mindful of information needed for a personal financial statement and history of payment and open accounts.”

Loan limits: Find a lender who will offer loans in the amount you need. Settling for a lower amount could burden you with loan and interest payments you may have trouble keeping up with, without sufficiently addressing your capital needs.

Term length: As unsecured business loans typically have shorter repayment periods than secured ones, that means higher monthly payments. In addition to the length of the repayment period, you’ll want to see how frequent the payments are.

Costs

As a business owner, you want profits earned from your business to go back into your company, not paid to a lender. Therefore, the loans that cost you less in the long run are typically the best for your business’s financial foundation. You’ll want to carefully review all the costs involved when shopping for a loan that will cost you the least. Be sure to consider the following:

• APR
• Down payment
• Origination fee
• Additional fees

You should also look for loopholes, recommends Burnham. Make sure you understand the true cost, which includes the interest rate and any fees, and whether there is a personal guarantee required. You’ll want to read the fine print and make sure there is no mention of a blanket lien that pledges your assets to the lender until you repay the debt.

Reputation

You’ll want to be able to trust the lender. Spend some time reading online reviews to learn the experiences by fellow small businesses. Read reviews from the aggregate review site Trustpilot, as well as the Better Business Bureau.

Watch out for online scammers. They often make credible-looking sites designed to trick you into sending them money for a loan that never materializes. “They can feel like a breath of fresh air, because they will approve your application when others won't,” says Detweiler. “But then they require you to send them money upfront to cover ‘the first three monthly payments’ or ‘insurance.’”

Signs that the supposed online lender is a scammer include not looking at your credit history during the application process. If an online lender doesn’t care about your creditworthiness, it isn’t interested in loaning you money. Online lenders are also legally required to register in the states they do business. If this isn’t easy to find on the company’s site, you can check with your state attorney general’s office. You can also check if there are any complaints filed with the Consumer Financial Protection Bureau (CFPB).

Strategies for Unsecured Business Loans

If you need money in a pinch and don’t qualify for an SBA loan or financing from a traditional lender, you want to proceed with caution when obtaining an unsecured business loan, which often comes with heftier fees and shorter repayment periods. It’s easy to overextend yourself, especially if you need the financing sooner than later. To prevent making costly mistakes, here are some tips when taking out unsecured business loans:

Write a detailed business plan.

Writing a detailed, thorough business plan is essential to getting any type of business loan. The lender will look carefully at the strengths and weaknesses of your business, including your credit trade lines with other businesses, existing bank account statements, profit margins and revenue projections, explains Mitchell. You’ll also need to include your personal and background info, as well as that of your business partners, and other major team members.

If you’re having trouble obtaining an unsecured business loan, reach out to the lenders that denied your application to pinpoint why your application was denied, and work on improving in those areas. Consider adjusting your business plan. Perhaps you don’t need as much funding as you initially thought.

Make sure your personal finances are in order.

Additionally, it is crucial for small business owners to ensure that their personal finances are in order, as this can often come into play when being considered for an unsecured business loan, Mitchell says. Make sure your personal credit score is as high as it can be, and your bills are paid on time.

Check your credit.

Check your personal and business credit scores before you apply for an unsecured business loan, advises Detweiler. If your scores aren't as strong as they could be, look at the factors impacting them to see if there are any you can address quickly. For example, personal scores are often impacted by high debt usage ratios on credit cards. Paying down high balances often results in an increase in your personal credit score.

Be prepared to answer questions quickly.

When it comes to unsecured business loans, small business owners should be prepared to answer questions related to the fundamentals of their business quickly and accurately, Mitchell says.

“Given the assumption of risk by lenders issuing an unsecured loan and the quick approval process, it is even more critical to address any follow-up questions in a timely manner, and as consistently and thoroughly as possible,” says Mitchell. Besides your business plan, have documents such as a valid form of ID, copies of business licenses, tax returns, bank statements, and proof of ownership on hand.

Plan out the use of funds.

Carefully plan out how you’ll be using the funds. If you don’t have a detailed plan for the money you plan on borrowing, you run into the danger of taking out more than you need and may have trouble paying back.

The duration and type of loan should match the purpose of the loan, recommends Mitchell. For instance, an unsecured line of credit can be an appropriate option for small business owners who need capital to cover short-term expenses such as payroll while waiting for customers to pay them.

“Banks typically charge interest only for the line of credit every month, and it is up to the customer to determine how much of the outstanding balance they pay every cycle,” says Mitchell. “This way, the line of credit is paid back as the borrower gets paid by their customers.”

In contrast, if a small business owner is looking to purchase a piece of equipment, they might operate for the next three to five years, a term loan is a more appropriate type of financing, explains Mitchell. That way, when the equipment or vehicle is done being useful, the loan will have been paid off.

Weigh the trade-offs.

Before getting an unsecured business loan, weigh the costs against the benefits to make sure it’s a sound choice. While unsecured business loans don’t require collateral and have a quick approval process, an unsecured business loan also is costlier for the borrower through higher interest rates and personal guarantees.

It’s always a good idea for small business owners to consult with their bankers, peers and accountants to get more information about whether an unsecured business loan is a good fit, recommends Mitchell.

Prepare to handle short repayment periods.

Because unsecured business loans typically have shorter repayment periods than other forms of financing, do the math and make sure you’ll be able to manage the payments. Carefully assess the profitability and cash flow of your small business.

You’ll also want to check and see if there are any prepayment penalties. Some lenders may charge a prepayment penalty, others may charge a prepayment discount that reduces the total amount of interest you'll pay, and others charge a fixed amount for the financing, regardless of how quickly you pay it off, Detweiler says. If you pay off your loan faster than you planned, any of those options will cost more than if you were only charged for the days the balance was outstanding.

Consider alternatives.

If you find that an unsecured business loan may not be the best fit for your needs, consider alternatives. For instance, if you have collateral you could offer but were reluctant to, it may make more sense to get a secured line of financing. You can also think of creative ways to tap in to financing, such as crowdfunding, asking friends and family for a loan, or using a co-op business structure, where those who invest in your business also have say in how it will run and may take a cut of the profits.

“Not all of unsecured loans are created equal,” says Burnham. “The most important thing you can do is research. Analyze what the loan will do for your company financially, not just now but throughout the entire term of the loan.”