Unsecured Business Loan Vs Secured Business Loan

If you are one of those smart people who have finally made it to the entrepreneur level, you must have found that it’s not easy. It requires a lot of tough decision making. From the type of business to production methods, hiring and firing there are a thousand matters to be resolved. In all the hype you cannot just forget finance. This is because it is the crux that holds your business together. You need it to keep your business running. But most businesses usually do not have enough capital to self-finance so they have to borrow. And the best and most common way to borrow is through loans.

However, borrowing itself is a complex decision. This is because the vast array of options makes it quite confusing especially for those new it. You can easily make the wrong choice and end up with a loan not suitable for you. So if you are thinking of applying for a loan to finance your business you must learn the basics. You have to at least contemplate the different options available such as unsecured business loans and secured business loans. That is why we have compiled a guide that can help you differentiate between these two major types. You can then easily decide the optimal one for your business.

What are secured business loans and unsecured business loans?

You must have often heard lenders and Funding Option teams mentioning ‘security’ for loans. You might not have understood it before. But it is a simple idea. It is a crucial thing that distinguishes between secured and unsecured business finance. So we will first look at what these loans truly are:

Secured business loans

These loans are backed by security. This in simple layman language means, that they are guaranteed by some valuable items belonging to your business. These lending are called are secured because the items that you have presented as collateral, act as a security if you fail to pay back. These loans are also known as asset-backed finance as they cannot occur without the support of business assets. These assets usually are tangible things such as property, vehicles, machinery, etc. But these loans can be complex as well. They can be secured through accounts receivable which are known as invoice financing. There are other lending options in it as well such as merchant cash advances that base security on terminal sales.

Unsecured loans

By contrast, unsecured financing has no backed asset. They have a high risk for lenders as they get no guarantee in cases when borrowers defraud them or get bankrupt. They cannot get their money back as they won’t have any collateral to assist it. But these generally have higher interest attached to them to make up for the higher risk. Moreover, these also tend to finance small sums and for a short period so that lenders can be relieved. This is common with mainstream banks who do offer unsecured loans but not above £40,000. Additionally, they are only given to a business with a good history! Gauging the profitability of the business and their payback history, lenders decide whether they should give such loans or not. Sometimes these loans are even based on multiples of turnover based on recent and anticipated financial performance. This acts as hypothetic security. Last but not least as there is more burden on the givers they don’t prefer such unsecured transaction thus you won’t find many willing lenders as well!

The differences between the two:

You can see the obvious difference between the definitions stated above. But there are other distinct features as well. We have formed a table to make it easier for you to compare them:

 

DifferenceUnsecured business loansSecured business loans
Backed byBusiness’s trading positionAssets
RiskHighLow
Time periodShort termLong run
AmountSmall sums of moneyLarge sums of money
RequirementsCredit checksGuaranteed Assets
FeasibilityLowHigh
Approval timeMoreLess
Legal requirementsLowHigh

 

The optimal choice for your business:

As we all know there is not a perfect finance solution for all businesses. As all businesses are different and have varying needs, they cannot expect to use the same type of finance. Even an individual organization cannot use the same type of finance to fulfill all their needs. So there has to be an optimal balance between the two. The right choice will depend not only on your preference but also on various factors. Sometimes you won’t even get the choice of unsecured loans because of your credit history. Most unsecured loans are only given to firms with good cash flow. So if you are a startup this would be very difficult to achieve. Your only remaining option will be secured loans then. In other cases, you won’t have any assets to give as a guarantee, so you will have to bear the high costs of unsecured loans. Moreover, you should also keep in mind the period, amount and purpose you require the loan for. This is necessary because even when you have both options available you will find on more superior over the other based on overall feasibility. For example, you already have too many secured loans on your profile, its best to balance the portfolio with an unsecured loan. If the amount is small and the purpose it is required is short-term then it will be easy to attain and repay them. Even though the cost may be high but it will free you from both the legal hassle and asset requirement.

However, if you require large amounts for longer periods, you will find it difficult and very expensive to find lenders willing to provide unsecured finance. Normally it will require a lot of time as well. No one is ready to take such high risk without background checks. You will have to provide business information like financial performance, and prospective financial statements. Credit checks will also be undertaken which can be bureaucratic and can lead to disapproval in the end. From the lenders’ point of view, the candidates for such loans are only limited. This is because they only prefer a business with extensive trading history, growth potential, and strong financial statements that reflect affordability to payback for such schemes. Unfortunately, this all makes it difficult for early-stage and medium enterprises to prove their worth to gain such loans. So in such cases, it is best to opt for secured loans if you have assets available.

Conclusion

The bottom line is with an increase in loan finance, it is necessary to be cautious. As small and medium-sized enterprise provides the banking sector with $70 billion worth of lending opportunities, they should also benefit from this lending themselves. For this, all business including yours, have to be perfectly knowledgeable to make the right decision. You cannot just rely on one type of finance. You will have to find the optimal one and for that, you have to compare your options. We hope we prove to be helpful here and now you would be able to weigh up the pros and cons of each loan according to the situation!

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