Similar to a tightrope walker in a circus, banks looking to provide businesses with a loan often require a safety net. More times than not, your business’ collateral is that safety net.
Collateral is the combined value of the assets your business has to help secure repayment.
Unlike capital, which deals with readily available funds, collateral is calculated through assessment of assets like real estate, inventory, receivables, and more.
A solid collateral base can help your business secure loans and reduce some concerns banks might have about providing one.
Identifying your financial safety net.
While all collateral helps secure your loan and reduce the risk for lenders, not all forms of collateral are treated the same.
As a general rule, collateral that is more easily converted into usable funds – like deposits, equipment, or real estate – tends to be valued more highly and can lead to more favorable interest rates for the borrower.
Similarly, there is no concrete amount of collateral your business needs when applying for a loan. While a diverse pool of assets does help, a business strong in the other three Cs of good credit may find it easier to secure a loan with more favorable terms.
For example, exhibiting good character through a consistent history of responsible behavior or demonstrating strong capital flow and balanced capacity can help to reduce interest rates on loans.
With collateral, there may be more than meets the eye.
When applying for a loan, apparent lack of collateral is not always a barrier to entry.
Through open conversation between you and your bank, an understanding can often be achieved. There are other ways for banks to ensure repayment, especially for businesses with strong foundations in the other three Cs – Character, Capital, and Capacity.
Even if it isn’t immediately apparent, there might be hidden collateral in any situation – your company’s inventory, receivables, or properties might have more value than you think.
Additionally, some service-based businesses without a large physical inventory may have their collateral evaluated based more on receivables and operating cash flow.
How can you improve your business’ collateral?
- Strengthening the other three Cs: A business that has a proven history of good character, demonstrates healthy capital flow, and has plenty of capacity often has less need of an abundance of collateral.
- Leaving no stone unturned: Examining all your business’ assets, you may discover that there is extra value in your existing collateral.
- Diversifying your investments: With a wider variety of assets your business has on hand, you’ll be better prepared for different loan options.
Summary
For a strong collateral base:
- Secure a variety of assets and build them up when possible.
- Ensure your business is strong in the other three Cs.
- Examine all assets for hidden value.
- Come into loan discussions prepared to be adaptable and versatile.
