It is hard enough these days to get a business loan. And, it is even harder to get an unsecured business loan. Hard but not impossible.
Banks tend to prefer secured loans – loans backed by equipment, commercial property, business assets, and even a business’s financial assets like accounts receivables, purchase orders, or inventory.
In fact, when banks tend to underwrite business loans, they look for three forms of repayment – as having additional sources to go to for payment makes them feel more secure in approving those requests.
The first form of repayment that these lenders tend to look for is from the business’s positive cash flow (profitable cash flow). Thus, they look for businesses that are generating more in revenue then they have in costs (all costs) as that additional income is the main method that most business borrowers will use to make their loan payments.
The second form of repayment that most banks look for is collateral. Something of value (real value) that could be taken and sold off if the borrower defaults – i.e. do not generate enough in revenue to make payments.
Lastly, banks will require personal guarantees – thus if the business or the business’s assets are not from you directly – not just from your business. For those of you living in the UK, check out Compare Banks to compare a variety of banks that you might be able to get business loans from.
Unsecured Business Loans
Now, when your company wants or needs an unsecured loan, you are essentially taking away one of the lender’s forms of repayment – which makes them real skittish. Thus, in order to get this type of loan approved, you, as the borrower, have to be able to demonstrate that the bank does not need any collateral in determining the creditworthiness of your business.
How can you demonstrate this? By ensuring that the other two forms of repayment that the lender requires are strong – very strong:
- Revenue Matters. The more revenue you have the better in landing that business loan. And, it is not just revenue by itself – but more about how much revenue is left over after the business covers all its expenses – including its direct expenses (related directly to earning that revenue) as well as its general and overhead costs. If there is something left over – usually called operating profits or Earning Before Interest, Taxes, Depreciation and Amortization (EDITDA) – that additional revenue is very valuable – valuable to the company in terms of what it can plow back into the company to make it grow, valuable to the businessís investors or other outside debtors and valuable in terms of profits the business owner can take out for all that hard work. But, that additional revenue is also valuable in the eyes of a lender – especially a bank. And, it is the value of that additional revenue that banks use in determining if they will approve or decline a business loan. Example: Let’s say that your business is generating, on average over the last few years, some $5,000 per month in additional revenue (operating profits). This means, to a lender, that your business has potentially $5,000 per month that it can use to make loan payments.
It also means, to the business, that the business has $5,000 per month that it can leverage into a large lump sum loan or even into a line of credit (usually called operating lines of credit as they are based solely on the business’s operating profits).
Therefore, with an additional $5,000 per month to service debt payments, your business could essentially leverage that into a business loan of around $155,000 at 10% for 36 months. Much easier to get a lump sum loan today and use it to grow your business today than having to save up that same amount over the next 30 months or so.
Now, let’s say that your business does want a $155,000 unsecured loan based solely on that operating profit – that cash flow. Given that $155,000 is the maximum amount your business could potentially qualify for – the bank or lender may bulk a little – as any downturn in your business’s sales could potentially make your company miss one or more payments. If your business only makes $4,000 in operating profit say one month after the loan is approved and funded (not the $5,000 it was making before) your business then stands a strong chance of not making that payment (something your bank wants to avoid). Thus, it is situations like these why banks like to back up their loans with collateral.
However, since you want your loan to be unsecured, you can’t do that – add collateral. So, more than likely that lender will say no to your loan request – it is just too close to call and so they tend to err on the side of caution.
So, what can your business do in situations like these – still wanting an unsecured business loan but not able to get it approved?
Here are two options:
- The first being to increase operating profits – by increasing revenue or reducing expenses or both. If you can provide an additional cushion, say another $1,000 per month in EDITDA then the bank might relax a bit as this additional revenue cushion could and should account for any potential drop in revenue that your business might face over the term of the loan.
- Or, the business could just simply ask for less in the loan amount requested. Let’s say that if the lender wants to have a $1,000 cushion from your operations before approving a loan, then your loan amount would be based on $4,000 per month in operating profits – not the full $5,000. This would make your maximum loan amount be about $124,000. Not the full amount of what your business wanted but not chump change either.
The goal here is to ensure the lender and their underwriters that your business can and will make those loan payments no matter what – that your business has the revenue and wherewithal to make those payments in all situations given that your loan is unsecured.
2. Personal Guarantees: Now, if your lender will forgo one form of repayment, like the collateral requirement, do not expect them to forgo another. Thus, if you want an unsecured loan you better come to the table with a strong personal financial background – having enough personal assets and personal income to cover the loan amount should your business not be able too. And, while this may seem that you are securing your business loan with your personal assets – it is not quite the same. These lenders may require you to sign a personal guarantee, but they will not encumber those personal assets – not on an unsecured loan. Personal Guarantees are essentially just a promissory note that states if your business does not pay, you will – personally – like a co-signer. Again, the goal is to make the lender feel that your business is worth the credit risk – and if you take away one of their safeguards– making your loan unsecured – you better have those other items (revenue and guarantee) in place and sturdy.
3. Relationship: A great way of ensuring that your business can land an unsecured business loan is to already have a strong relationship with that bank or lender – especially a bank. Banks can make a lot of money from the other services they offer – like checking accounts, sweep services, merchant processing, payroll, trust services, etc. And, if they are making money from those items already – from your business – they tend to do things out of character to keep earning that money – like approving unsecured loans. Example: I use to bank a business owner that owned and operated two local nursing homes. Now, this person came to me one day seeking a $250,000 unsecured business line of credit – a line that he was going to use to smooth out his cash flow over the year. However, after running the numbers – I could not find a way to get that loan request approved – not based on the guidelines set out in our loan policy as the company was just not making enough in operating profits to justify the loan (he was close, but not close enough). So, I declined that loan application.
At that time, all of our declines had to go through our bank president – kind of a second review. When this particular deal hit the president’s desk, he immediately approved it.
The reason he did this was because of the relationship that the business owner already had with our bank. Not only did this business keep, on average, some $400,000 in its business checking but the business – not to mention the business’s owner – held several profitable accounts with us.
Thus, having that relationship helped this business land that unsecured loan – even when our lending policy said to deny it.
Not all business lenders offer unsecured loans. In fact, assets based lenders, alternative lenders, and equipment and commercial mortgage lenders all require some form of collateral – it is just the nature of the products they offer.
Banks, on the other hand, can and will provide unsecured loans to the right businesses.
Thus, you have to ensure that your business is the right one – one that has a track record of solid, ongoing operating revenue, one that can offer a personal guarantee that actually has substance to back that guarantee up as well as one that already has a profitable relationship with the lender – a relationship that the lender is afraid to lose.
If you can put these items in place, then you should have no problem landing that coveted unsecured business loan.
You may also like: Raising Funds for Your Business – How Can I Do It?
About the Author
Chad Otar is the CEO at Excel Capital Management, a pioneer in the Fintech and alternative lending space. He has assisted thousands of business owners to receive funding over the last 5 years and is focused on helping one small business at a time to achieve access to capital.