Small Business Loans: Secured vs. Unsecured

Are you struggling to determine the right type of small business loan for your business? Understanding the differences between unsecured and secured small business loans is a great place to start.

In this article, we break down the differences between the two.

What is a Secured Small Business Loan?

A secured small business loan is a loan that requires some form of collateral to help assure the lender that the loan will be repaid.

When you take out a secured loan, you’re giving the lender the right to seize and sell the collateral you have pledged if you default on your payments. Collateral often includes inventory, equipment, or vehicles. 

This reduces the risk associated with your small business loan. While the lender prefers that you repay what you owe according to the agreed upon repayment schedule, if you fail to do so, the lender may use the pledged collateral to recover their money or recoup their losses.

By providing collateral to secure the business loan, you have more at stake and the lender assumes less risk. As a result, secured small business loans often offer more favorable loan terms such as lower interest rates, a longer repayment period, and higher loan amounts.

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Examples of secured small business loans include:

• Equipment loan. An equipment loan can help businesses purchase new equipment or replace existing equipment used to run the business. In this case, the piece of equipment being purchased is typically used as the collateral for the loan. 

• Inventory financing. Businesses can turn to inventory financing to get access to capital to pay for materials they need to manufacture products they can sell at a later date. The products themselves serve as the collateral for the loan.

• Receivables financing. Some businesses face significant cash flow gaps waiting on their customers to pay. Receivables financing provides capital for outstanding invoices that businesses can then pay back once they have received payment from their customers. This often comes in the form of invoice factoring, which can be expensive and tedious as a lender underwrites each individual invoice. Some lenders will provide revolving lines of credit for accounts receivable with an overall limit that can be drawn for any invoice. 

• Asset-based financing. Any of the secured business loans above may be considered types of asset-based financing — or asset-based lending. Some lenders, however, may offer asset-based financing that combines these different types of secured business loans for a more holistic view of your collateral. By examining both accounts receivable and inventory, for example, a lender may be able to offer you a higher loan amount. 

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Advantages of a Secured Business Loan

Secured business loans offer the following advantages:

• Lower interest rates
• Higher loan limits
• Longer repayment terms
• Requirements are less strict
• Choose specific assets to use as collateral in a loan agreement

Lenders offering secured business loans provide the above benefits because they know they can use the pledged collateral to recoup their losses in the case of a default. By putting your assets on the line and shifting financial risk from the lender to yourself, the lender is able to provide more favorable loan terms. 

Business owners seeking a longer-term financing partner may opt for a secured business loan, as the interest rate savings will add up over time. 

Secured business loans can also be a good solution for startups if they lack the financial history required for an unsecured loan. Plus, lower interest rates can be especially appealing to earlier stage founders that are trying to get their business off the ground. 

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Disadvantages of a Secured Business Loan

Secured business loans also have the following disadvantages:

• Takes longer to process
• Assets are on the line in case of a default

A secured business loan can take a while to process because the lender must carefully evaluate all of your collateral. Before releasing funds, the lender needs to ensure that the assets being pledged are comparable in value to the loan amount being requested. This can also mean more back-and-forth communication between and the lender as they learn about your business. 

On average, secured business loans take about two to three weeks to process. If you are seeking immediate access to funds, applying for a secured business loan may not be the right choice for you.

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What is an Unsecured Business Loan?

An unsecured business loan is a type of commercial loan that doesn’t require collateral. To get approved for an unsecured business loan, you need to demonstrate your creditworthiness as a borrower.

Lenders that offer unsecured loans typically use “intangible assets'' alone to determine creditworthiness. This may include a credit report, investment portfolio, a financial statement, or any document that assures lenders they will be repaid on their investment. Some lenders may ask borrowers for a personal guarantee as an extra layer of security.

If a small business owner defaults on an unsecured business loan, the lender cannot seize any property since no collateral has been pledged. Instead, the lender will seek other avenues to recoup their losses, such as hiring a collection agency to collect unpaid receivables or seeking legal recourse. 

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Examples of unsecured business loans

• Credit cards. Most credit cards are unsecured. Instead of requiring collateral, credit card providers typically check your credit history during the approval process. If approved, your card’s interest rate and credit limit will be based on your credit history.

• Student loans. A student loan is an example of an unsecured business loan, as it doesn’t require collateral. Students who are approved  as students who get approved don’t have to pay back until they leave school.

• Personal loans. Banks will provide personal loans based on their history and relationship with an individual. The person applying for the loan does not need to pledge any assets to receive financing. 

• Merchant cash advance. Technically a merchant cash advance (MCA) isn’t a loan. But it is a financing solution available to small businesses. A MCA provides cash up front in exchange for your future sales. Rather than paying back the cash based on predetermined loan terms, a MCA essentially intercepts your revenue from credit card sales or receivables. 

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Advantages of an Unsecured Business Loan

Unsecured business loans offer the following benefits:

• Quicker access to funds
• You do not risk losing any assets 

Since unsecured business loans are easier to process, small business owners can get access to funds more quickly — in some cases, on the same day they submit an application. The lender will perform background checks, credit checks, and an assessment of your business finances. But they don’t need to evaluate your pledged collateral or understand the nuances of your business to the same extent. 

Small business owners who get approved for an unsecured business loan can typically access the funds by the following business day. And because the loan doesn’t require collateral, if there is no personal guarantee, you are not at risk of losing existing assets.

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Disadvantages of an Unsecured Business Loan

Here are the cons of using an unsecured business loan:

• Higher interest rates
• Smaller loan amounts

No-collateral loans shift the risk from the small business owner to the lender. To minimize the financial risk, unsecured loan providers charge higher interest rates and offer smaller loan amounts.

By taking collateral out of the picture, unsecured loan providers instead evaluate your creditworthiness by checking your credit history and business health. For example, they may ask you to submit a cash flow statement demonstrating you have enough working capital each month to repay the loan.

Signing a personal guarantee can be risky because it allows the lender to pursue you personally if you default on your payments. What that entails specifically will depend on the loan agreement, but personal guarantees don’t typically come into play unless you default on the terms of your loan and are unable to correct the default.

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Secured vs Unsecured Small Business Loans: Which is Right for You?

Is the right loan for your small business secured or unsecured? 

That will depend on the goals and circumstances of your business. How large of a loan do you need? What is the level of urgency? How much are you willing to spend for the funds? Are you looking for a short-term or long-term financing solution?

If you’re looking for a quicker, shorter-term solution and are willing to pay higher rates for a smaller loan amount, an unsecured loan may be the best option. If you’re looking for a more cost-effective solution that will scale with your business and you’re able to spend more time on the application, a secured loan is likely favorable.  

The chart below can help you weigh your options, but may not apply in all cases, as different lenders will provide different loan terms. 

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If you’re just starting out, a secured business loan may be your best — or only — option to access a significant amount of cash. By using your assets as collateral to secure the loan, you are likely to be granted more favorable loan terms, including lower interest rates and the ability to pay back the debt over a longer period. Plus, you’re more likely to access larger loan amounts that enable you to accelerate business growth.

If you’re a business owner seeking quick access to funds you may want to go with an unsecured small business loan. While you’re likely to pay higher interest rates and receive less favorable loan terms, an unsecured loan will give you quick access to the cash you need. This can be a great solution for covering immediate business expenses and improving cash flow in the short-term, but may not be the most cost-effective long-term financing partner.  

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Fueling Growth with Aion’s Secured Small Business Loans

Aion provides different types of secured business loans to meet the needs of your unique business circumstances. We provide term loans and revolving lines of credit backed by invoices, inventory, or a combination of the two. Secured loans enable us to provide more favorable terms to our customers. Our range of products ensure we are a long-term solution that scales with your business. 

Contact us to speak with a business lending expert today.