What is an Unsecured Business Loan?
There are two general categories of business loans – secured and unsecured. In the case of secured business loans, a small business borrower will post a specific piece of collateral in the form of a valuable asset – including real estate, inventory, or manufacturing equipment – that a lender can potentially seize (and sell) in the event of non-repayment.
This posting of collateral helps mitigate risk to the lender – but in the case of unsecured business loans, borrowers are not required to put up collateral. This benefit does,however, come with a cost – as lenders will attach higher interest rates to unsecured business loans.
Since the absence of collateral increases risk to lenders, they often respond by requiring some form of a personal guarantee that permits a lender to pursue a borrower’s personal assets in the event of non-repayment. So, in essence, an unsecured business loan is a loan that a lender provides without requiring some form of valuable collateral backing. However, rest assured, there are methods that lenders utilize to protect themselves in the event of non-repayment.
What is a Personal Guarantee?
A personal guarantee is commonly included in the terms related to an unsecured business loan. With a personal guarantee, the business owner is effectively co-signing for the unsecured business loan, as the owner’s personal assets – house, car, investment accounts, savings accounts, etc. – become susceptible to seizure and sale by the lender in the event of non-repayment.
Many small businesses simply lack the specific valuable assets that could potentially serve as collateral to a secured loan, leaving unsecured loans as the only viable option. Banks and other lenders must manage lending risk, and personal guarantees help lenders in this manner.
The Various Types of Personal Guarantees
In the case of an unlimited personal guarantee, the borrower agrees to allow the lender to recover the full amount of the loan, including interest, along with all corresponding legal expenses incurred. In the case of a limited personal guarantee, most often utilized by multiple business partners, clear parameters are put into place as to the percentage of liability that each individual partner should be responsible for in the event of loan default. Small Business Association guidelines indicate that any business partner with a 20% or greater ownership stake should be included within a limited personal guarantee.
Furthermore, there are two types of limited personal guarantees: several and joint and several. In the several scenario, individual partner liability percentages and the associated possible worst-case scenarios are clearly defined. However, under the joint and several scenario, each individual partner is potentially liable for the full amount of the loan, including interest and legal expenses. The lender cannot pursue more than it is owed, but it can choose which partner(s) to target, and this implies that the worst-case scenario for any of the individual partners is 100% liability – even if that partner’s ownership stake in the business is significantly less.
Virtually all unsecured business loans include a business lien (generally within the fine print) that is designed to protect the lender in the event of default. The existence of a business lien allows the lender to sell certain assets of the business when non-payment occurs.
Certain business liens target only specific assets of the business, generally those that the loan principal helped to purchase. However, a blanket business lien, if included within the terms of an unsecured business loan, permits the lender to sell any and all assets of the underlying business (up to the amount of the loan, plus interest) in order to collect on funds owed to the lender.
Things To Do Before Taking an Unsecured Business Loan
It may sound obvious, but before committing to an unsecured business loan, be certain to research and shop around for the best terms and interest rate available given the credit score and profile of the underlying business and any individuals who may become participants of a personal guarantee.
Be prepared to offer as much detailed financial information as possible on your loan application, and be fully aware of the existence and nature of any personal guarantees and business liens that accompany the unsecured business loan. To get yourself started, consult the related pages on our website related to two of the more popular unsecured business loan lenders in the marketplace.
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