This is why it’s crucial to ensure that your business is operational and liquid. Unlike large, established companies that tend to have huge capital reserves, small businesses might not have as much money on hand. And that can quickly become a problem when sales revenue drops or when there’s a need to invest in capital or labor.
But a great way to handle the financial ups and downs of running a business is with a small business loan. Loans allow you to operate with enough cash on hand to thrive.
Traditional banks and financial institutions ask for a great credit score and collateral for most commercial loans. If you don't have that, don’t worry. In this case, a business loan without collateral can help you get the cash you need.
Business loans that require no collateral are also called unsecured business loans. They offer many advantages to small business owners who need the money to expand or to cover short-term expenses.
If you're considering a small business loan and don't have collateral or the best credit score, read on to learn everything you need to know about unsecured business loans.
What is an Unsecured Business Loan?
An unsecured business loan allows small businesses to borrow money even if they don’t have collateral to secure the loan.
Secured loans, on the other hand, require collateral. This means you need to have a high-value business asset, such as real estate or a vehicle, to qualify for the loan. These types of loans tend to be larger, which is why they need to be secured. Higher loan amounts represent a greater risk for the lender — so they need to have assurances about repayment.
To get an idea of what type of business would need a secured loan vs. an unsecured loan, here’s an example: an enterprise-sized chemical company that wants a $1,000,000 loan to invest in research and development — and that has plenty of assets to back up the loan — would take out a secured loan.
On the other hand, a flower shop may have plans to borrow $25,000 to pay their supplier in bulk for florals and ribbon orders (which their supplier gives them a discount for). They might choose an unsecured loan.
Because unsecured loans are more flexible, the shop might also use some of the loan amounts to cover training costs for a new employee or to renovate their storefront so it’s more appealing to customers.
The key differences are that unsecured business loans are usually smaller in value and they often have a shorter term. This poses less risk for the lender, so they don't require collateral.
So what do financial institutions look at when issuing business loans without collateral?
While they won’t ask for security to back up the loan, lenders will still carefully analyze your business statements and financials, your credit score, and business history. This information determines if your business is creditworthy.
Basically, the lender wants to verify that your business won’t default on the loan.
So, in addition to business documents, unsecured loan providers might also request the following information:
- Personal guarantee signature: This guarantee means you agree to personally pay back the loan through your personal assets if the business is not able to pay it through revenue.
- A blanket UCC lien agreement: This allows the lender or creditor to seize your business assets if you fail to pay back the loan.
Why Should You Get a Business Loan Without Collateral?
Loans without collateral can be an extremely practical solution and a type of loan perfect for small businesses looking to scale.
More often than not, unsecured business loans have more lenient qualification requirements, so you could be eligible without having to meet a long list of requirements. This means less paperwork and a more streamlined loan application process.
This type of loan is also more accessible. Financial institutions requiring collateral usually want real estate, cars, or other high-value assets, making it more challenging for small businesses to secure loans.
For example, if you lease your office space or work equipment, you might not have a high-enough value asset to get a secured loan.
While there are many pros to getting a no collateral business loan, keep in mind that they do carry higher loan rates than secured loans. And the requirement for a personal guarantee shifts the risk onto you because your personal assets could be used for repayment.
This is why it’s wise to keep these types of business loans for smaller amounts. They are ideal when you need short-term cash to cover operational expenses or to take advantage of a business opportunity.
As an example, a cafe might need to cover its labor costs during the slow winter season, knowing business will pick up when the tourist season starts in the spring. So, they only need $50,000 and will be able to pay the loan back quickly.
To determine whether unsecured small business loans fit your particular needs, let's look at the advantages and disadvantages.
Advantages of Unsecured Business Loans
The main benefits of unsecured small business loans are:
- Easy to obtain. Unsecured business loans have a faster application process, and you won't need a lot of documents. Lenders will look at your business statements and credit score.
- Quick approval. Because these business loans are short-term and for smaller amounts, you might get approval within a few business days.
- Few restrictions on usage. While secured business loans have a clear purpose, such as buying property or purchasing new equipment, you can use unsecured loans for any unspecified business purposes, as long as you're not using the funds for illegal activities, buying securities, or gambling.
- Your assets are safer. Even if you default on the unsecured loan, lenders may not seize your business or personal assets immediately. They have to obtain a court order.
- Loans may be discharged upon bankruptcy. If your business doesn't succeed and you file for bankruptcy, the court may discharge you of your unsecured loan.
Disadvantages of Unsecured Business Loans
Unsecured loans give your business the chance to grow without taking out a huge sum of money with extensive collateral. But there are some downsides you should know about.
- You need a personal guarantee. As specified, many financial institutions ask you to sign a personal guarantee. This allows them to seize your personal assets or make you repay the loan with your personal savings if your business does not generate enough money to pay it back.
- Higher interest rates. Because your business doesn't have any collateral to provide for the loan, financial institutions usually charge a higher interest rate to cover their risk. This makes borrowing more expensive.
- More frequent payments. Unsecured business loans have shorter repayment terms, so you might need to pay off the loan in a smaller time span than if you had a secured loan with a flexible repayment option.
- You need a good credit score. It might be challenging to get an unsecured business loan if you have bad credit. Since other types of financing require collateral to secure the loan, you will need a good credit standing to qualify for unsecured financing.
6 Types of Unsecured Business Loans You Can Get
Small business owners have a variety of loan options, especially for unsecured business loans. Let's take a look at some of the most common unsecured business loans you can use for financing your next business investment.
- SBA 7(a) loans
The U.S Small Business Administration (SBA) provides assistance for small businesses through their SBA 7(a) loans program. Most Small Business Administration 7(a) loans are secured, but the collateral requirement may be waived for business owners looking to borrow $25,000 or less.
The government wants to stimulate new small business investments, so they make SBA loans attractive by having relatively low interest rates and long repayment periods. And if you can use the money to grow, the U.S. SBA is more likely to continue offering you these attractive loans.
Consider the example of Creative Playgrounds’ Montessori Schools and Child Care Centers. This Ohio business grew from two employees and one location to a 260-strong team and eight locations thanks to a series of SBA-backed loans. Today, it generates over $1 million in revenue.
But because these loans are limited, the eligibility criteria can be stringent and call for more documents upfront.
SBA loans also take longer to disburse than other types of unsecured financing, so if you're looking for immediate money, they may not be right for you.
- Term Loans for Businesses
Term loans are designed to provide a lump sum of money that borrowers repay in fixed installments over a period of time. This type of financing can be short-term, so for only a few months, or long term with repayment periods of several years.
Small businesses can qualify for these loans without collateral, especially if they borrow from online term lenders.
Online lenders are more flexible in their requirements. They may even provide financing if your business or personal financial situation is not the best or if you have a low credit score.
Due to this flexibility, interest rates for unsecured term loans tend to be higher. The loan duration will also impact the interest rate: the shorter the term, the lower the rate.
- Merchant Cash Advances
An easier way to access funds is through a merchant cash advance. The way these loans work is that merchant cash lenders provide your business with a lump sum of money. Then, you repay the amount with a percentage of your future revenue.
You can repay these loans through factor rates, which include a daily or weekly percentage of your business revenue.
This is a great option for retail shops, coffee shops, and other small businesses that sell directly to consumers. When your customers make purchases, a portion of your card sales goes toward paying off your merchant cash advance, so you don’t have to worry about making repayments.
Also, if you have poor or bad credit, a merchant cash advance can be a good option. It requires fewer documents, and the funds are immediately available to you in daily or weekly remittances.
Your repayment period and sum also depend on your sales, so if your sales increase, so does your repayment sum and vice versa.
While merchant cash advances provide immediate financing, they can also take a toll on your profits. And, depending on your annual revenue, they could take longer to repay.
- Unsecured Credit Lines
Any financial institution can provide you with an unsecured credit line for your business. Your bank or other lender allows you to borrow money up to a specified amount. You can borrow less than that amount or the total.
As you repay the amount borrowed, your credit line is freed up by the amount you pay. Let's say you get a $20,000 line of credit, and you borrow all of it. If you repay $500 in one month, you can borrow $500 again from your line of credit.
Lines of credit are great for businesses with a limited credit score and history, but you should make sure to read all the terms and understand the fees before taking one. Because it's such a convenient way to access financing, lines of credit tend to have higher fees and interest rates.
- Business Credit Cards
Credit cards aren’t exactly a type of loan, but you can access these “funds” at your convenience. A business credit card can be helpful when you are short on cash and need to make purchases immediately. Of course, your credit card limit depends on many factors, including your credit history, the annual revenue of your business, and the time operational in business.
Before getting a business credit card and using it, check the fees and terms. Many credit cards require you to pay your balance in full or penalize you with overdue fees, so you might end up paying more than if you were to use an SBA loan or a term loan.
- SBA Disaster Loans
If your business has experienced losses because of an economic crisis or natural disaster, you might qualify for a disaster loan by the Small Business Administration (SBA). For example, if your business was temporarily shut down by a government mandate, then you might be eligible for such a loan.
Disaster loans under $25,000 do not require any collateral, so you can get them quickly and easily. The application process is straightforward, and if approved, you will have access to the money in a month or two.
Steps to Get an Unsecured Business Loan
Getting an unsecured business loan is not as challenging as a secured loan. The process is quicker because there is no need to submit documents related to your collateral and its value. And you won’t have to wait as long for the lender to disburse your funds.
So if you have made up your mind about getting an unsecured business loan, here’s what you need to do to get started.
Step #1: Choose From Your Many Options
There are many unsecured business loans out there, each with pros and cons. To help you narrow down your search, visit your preferred financial institutions, or get a quote from an online lender like Advance Point for a number of flexible loans.
Once you have a thorough understanding of your options, pick an unsecured business loan that suits your financial goals and needs.
Step #2: Review Your Business Financials to Determine Whether You Qualify
When reviewing your unsecured loan options, check the eligibility criteria and documentation needed for each one. Some loans have more stringent requirements than others, so you might need to prepare beforehand and get your documents ready to apply.
For example, suppose you want to get an SBA 7(a) loan. In that case, your business must have been operational for at least two years, qualify under the SBA's definition of a small business, and have a specific minimum credit score and annual revenue.
The SBA office and any other lender can go through each requirement with you if you need help.
Other types of unsecured loans, such as merchant cash advances or a line of credit, are less demanding.
Whichever unsecured business loan you choose, you should prepare the following documents to hand in during the application process:
- Your personal financial documents
- Your business financial statements, such as a balance sheet, income statement, and a cash flow statement
- Detailed documentation on your business expenses
These documents will speed up the process of getting your unsecured business loan and make it easier for lenders to evaluate your eligibility.
The numbers in those documents, along with your personal and business credit scores, will give lenders a clear picture of your ability to pay back the loan, and if you have a favorable position, you might get better interest rates, a larger loan amount, and lower fees.
Step #3: Get a Personal Guarantee or UCC Lien
Before asking for an unsecured business loan from a bank or alternative lenders, you should get a personal guarantee or Uniform Commercial Code (UCC) lien.
Your lenders may require these documents to prove that even if your business fails or cannot repay the loan, you can pay it off through your personal funds. Otherwise, the lender can seize your personal assets.
So although your business assets are not part of the collateral requirements, your personal assets can serve as a guarantee that you can repay your debt.
These documents will signify to your lender that you are serious about getting business financing from them and are ready to put your personal finances and assets on the line. If you do file for bankruptcy during this time, a court may discharge the unsecured loan — but this has other legal and financial ramifications that need careful consideration. They’re not a viable way out of repaying a loan.
Step #4: Analyze the Terms Before Signing
Once you've applied for your desired unsecured business loan, such as an SBA loan or business credit cards, and you've been approved, go through the loan terms. Review the loan agreement, look carefully at the interest rate and related fees, and think about the payment schedule.
You can even seek advice from your accountant or an experienced financial advisor so you make the best decisions possible for your business. In the end, you should have a clear picture of what you're expected to pay every month and for how long.
When you are confident that you understand the small business loan terms and conditions and can meet these financial obligations, you can sign the loan agreement.
Then, you’ll be able to access funds that grow your business!
Unsecured business loans are usually easier to qualify for, and the funding process is faster. Plus, your business doesn’t have to offer up any business assets as collateral. This is a huge advantage for any small business that needs financing right away to keep operating or to take advantage of a business opportunity.
But, you’ll pay higher interest rates and fees, making these loans more expensive than secured business loans.
No matter what type of loan you choose, you’ll want to choose a trustworthy, experienced lender that understands the unique needs of small business owners.
At Advance Point Capital, we provide a variety of small business loans, including SBA 7(a) loans, invoice financing, lines of credit, and more. More than 7,500 businesses choose to get financing from us. Apply today in only a few minutes and get funding in as little as 24 hours.