Unsecured business loans are financial tools harnessed mostly by entrepreneurs, startups, and business owners. By taking out unsecured loans, businesses can secure the funding they need to create a new business from the ground up, buy supplies and equipment, and manage their cash flow.
Unlike secured business loans that require the borrower to put down collateral, unsecured business loans don't have such a requirement. Thus, borrowers who need cash for their business can use unsecured business loans without putting down a considerable deposit or pledging their home or other assets as back-up if they can't pay
While not right for everyone, unsecured business loans can solve many financial shortages and funding problems businesses have. Keep reading to learn more about unsecured business loans and who they work best for.
Myths About Unsecured Business Loans
Although people tend to believe that unsecured business loans are less risky and less expensive than secured loans, this isn't necessarily true. Read these myths about unsecured business loans, plus the reality behind them:
Since I didn't put down collateral, no one can make me repay this loan if my business fails.
are less risky.
are easier to get and
Why Choose an Unsecured Business Loan?
The biggest advantage of an unsecured business loan is flexibility. By not having your loan tied to an asset, you can borrow the amount of money you actually need. And if you don't have significant assets, an unsecured business loan may very well be your only option. (Just remember that your lender can come after all your assets if you default.)
The table below highlights some of the biggest benefits and drawbacks of both secured and unsecured business loans:
|Unsecured Business Loans
- No collateral required
- Less paperwork and minimal hassle
- Perfect for investors with few assets
- Ability to borrow higher amounts than you can with a secured loan
- Higher interest rates on average
- Lenders can go after all your assets if you default
- Unsecured loans tend to come with shorter loan terms
|Secured Business Loans
- Lower interest rates on average
- Lenders can only seize your collateral if you default
- Unavailable to business owners who don't have assets to use as collateral
- The requirement for collateral may limit the amount of money you can borrow
Alternatives to Unsecured Business Loans
If you're worried about the risks that come with unsecured business loans, consider another type of business loan - a self-secured business loan. Here are two of the most common types of self-secured business loans:
Equipment loans allow you to borrow money to purchase equipment for your business, then use the equipment you purchase as collateral for your loan.
Invoice Financing Loans
If you're having trouble making payroll due to unpredictable cash flow, invoice financing loans are a good option. These loans typically charge 15 percent of what's owed until all invoices are paid, then return the balance minus their fees.
Common Types of Unsecured Business Loans
If you're leaning towards an unsecured business loan for your business, here are a few of the most common types:
Working Capital Loans
According to the Small Business Administration, "working capital" is defined as the difference between current assets and current liabilities. Working capital loans extend your working capital by offering additional funds you can use to keep your business afloat. These loans are best for anyone who needs to borrow additional cash to keep machinery running, meet payroll, or raise cash for improvements.
Business Credit Cards
Business credit cards provide a flexible line of credit for business owners who need occasional help with cash flow. The biggest advantage that comes with business credit cards is that you can use them as needed with no commitment to carry a balance. According to the SBA, small business credit cards also allow business owners to protect their personal credit rating while building their business credit.
Personal loans can be used as an additional type of unsecured business loan. Generally speaking, you can take out a personal loan from a credit union or bank and use the money to fund your business pursuits. To qualify for these loans, you need a decent personal credit history and score.
How to Qualify for an Unsecured Business Loan
To qualify for an unsecured business loan, you'll need to produce certain documents that can prove your creditworthiness and demonstrate your abilities as a business owner.
Plan to gather the following documentation before you meet with a lender for an unsecured business loan:
Bank statements from your business bank account may be needed to confirm certain financial details described in the rest of your loan package.
Business credit report
Your lender will want to examine this document to see how your business has managed its credit and funds so far.
Lenders will expect you to have a professional business plan that details your business goals and plans for profitability. Your business plan should include financial projections, cash flow, and balance sheet and relevant details on your organization's financial health.
In addition to all of the loan documentation required by your business, some lenders may require signed personal financial statements as well. These statements may include financial details required by your bank, along with proof that you own at least a 20 percent stake in the company.
Income tax returns
You may need to bring up to three years of your personal income tax returns to verify your income from prior years. How many tax returns you need to submit depends on your individual lender.
Legal documents required to secure your business loan can include, but are not limited to, business licenses and registrations, articles of incorporation, contracts with third parties, commercial leases and franchise agreements.
Personal background information
The lender will ask you to provide some personal information. Details needed may include previous addresses and names used, your criminal background, if any, and your educational background.
Personal credit report
You'll need to provide your personal guarantee for the loan. As a result, the lender will examine and verify your personal credit history.
Some lenders may ask for your resume in order to verify your education and employment background. Provide an honest list of your work and education.
Dan LaFayette is Lending Tree's senior product manager for business loans and oversees the company's small business loan division. In this interview, he gives his expert take on unsecured business loans.
What type of business is the best candidate for an unsecured business loan?
We generally find businesses that have been operating for over one year and maintain $100K+ annual revenue have the most success with being approved. Businesses who meet these qualifications represent a lower risk to lenders and often can be best served by their products.
Of course, there are still lenders available for those businesses that may not fit this mold, such as startups. However, because startups do not have a proven record of operating success, this represents higher risk for lenders, and the reality is candidates may not always be approved or approved for the full amount they are seeking. Lenders are not the same as investors and are really looking to make a fair, profitable margin while balancing risks.
What is the most common type of unsecured loan available to businesses?
Probably a cash flow or short-term loan. Cash flow loans help businesses with their daily cash flow, and the cash that the business generates is viewed as collateral for the loan. Short-term loans are typically loans that are repaid within three months to three years.
How can someone present themselves as a good candidate for an unsecured business loan?
Lenders are looking for low-risk situations and do not operate the same way as investors who are looking to gain a significant monetary return. Typically, an ideal candidate would be one that has been in business long enough, has substantial revenue, and does not have large debt service, but needs a loan to help them with their own sound business investment and/or immediate cash flow needs. The Debt Service Coverage Ratio is a good indicator for a company to be able to pay off debt over time.
Any business owner seeking a loan, however, would best be pre-prepared with necessary documents, including financial statements, income tax returns, and legal documents. Having this information organized and readily available will quicken the process so you can get an answer regarding your loan inquiry sooner.
The U.S. Department of State offers a wide array of resources for new businesses.
SBA Loan Programs
Learn about loan programs offered through the U.S. Small Business Administration.