Countless business owners rely on financing to get their companies off the ground. Getting a small business loan can be a game-changing step toward your goals as a business owner, and there are multiple forms of financing to explore. A small business loan can be either secured — backed by collateral like assets — or unsecured — relying on your creditworthiness. To decide between the two, take a look at your business’s needs and risk tolerance.
What Is a Secured Business Loan?
A secured business loan is a type of financing that involves a form of collateral, such as assets or property. This collateral serves as a guarantee for the lender, reducing the risk related to the loan and potentially leading to lower interest rates for the borrower.
Example of a Secured Business Loan
Here’s an example of this form of loan: a company specializing in manufacturing machinery might seek a secured business loan to expand its production capabilities. This company could use the loan to purchase advanced equipment or meet other needs. By offering some of their existing equipment as collateral, the company can secure favorable loan terms like a lower interest rate or a more flexible payment plan.
Pros and Cons of a Secured Business Loan
Pros:
- Collateral reduces the lender's risk, resulting in more favorable interest rates.
- With collateral, businesses can secure larger loan amounts compared to unsecured options.
- Secured loans are often more accessible, making them suitable for businesses with valuable assets.
Cons:
- Defaulting on payments may lead to the seizure of pledged collateral.
- Due to the need for collateral valuation, the application process can be more time-consuming.
- Businesses without substantial assets may find it challenging to qualify.
What Is an Unsecured Business Loan?
An unsecured business loan is a financing option that doesn’t require any collateral. Approval for this type of loan is based on the borrower's creditworthiness, financial history, and business strength. While more flexible, unsecured loans often come with higher interest rates and lower loan amounts compared to secured loans.
Example of an Unsecured Business
Here’s an example of the use of an unsecured business loan: a tech startup that needs capital for software development may opt for this form of financing to avoid collateral. The loan is approved based on the company's creditworthiness. Approval gives the startup access to funds for projects, hiring skilled professionals, and growing its operations without the risk of losing valuable assets.
Pros and Cons of an Unsecured Business Loan
Pros:
- Borrowers don't need to pledge assets, reducing the risk of asset loss.
- The lack of collateral simplifies the approval process, making funds available as fast as possible
- Startups can easily access funding based on creditworthiness alone without any need to risk losing assets.
Cons:
- Unsecured loans often come with elevated interest rates due to the increased risk for lenders.
- Compared to secured options, unsecured loans typically offer lower funding limits.
- Approval relies heavily on the borrower's credit history and financial stability, making it difficult for some companies to get approval.
Is a Small Business Loan Secured or Unsecured?
Small business loans can be either secured or unsecured. The key difference between a secured and unsecured loan is whether the loan requires you to present some form of collateral. In that case, it’s a secured loan. A loan that doesn’t require collateral is labelled unsecured in business finance terminology.
Secured vs. Unsecured: How To Determine the Right Loan For Your Business
Choose a secured loan if your business has valuable assets, needs lower interest rates, and has a higher amount of capital to raise.
Opt for an unsecured loan if flexibility and faster approval matter more, even with higher interest rates. Assess your assets, risk tolerance, and financial needs to determine the best financing option for your business.
Key Factors in Loan Decision-Making
- Interest Rates: Consider the cost of borrowing and choose loans with favorable rates.
- Loan Terms: Look carefully at repayment periods and choose terms aligned with your business's cash flow.
- Collateral: Evaluate whether you can provide collateral for better terms or prefer unsecured options.
- Creditworthiness: Know your credit score, as it impacts eligibility and interest rates.
- Purpose: Choose loans that align with your business goals, whether for expansion, equipment, or working capital.
- Lender Reputation: Research and select reputable lenders with transparent terms and good customer service.
Is a Small Business Loan Secured or Unsecured? The Bottom Line
Small business loans can be either secured or unsecured. In general, the best option for your company depends on factors like your creditworthiness, how long you’ve been active, and how much funding you need. Both forms of financing can help you reach your goals, but it’s best to decide between the two on a case-by-case basis.