Unsecured business loans don’t require collateral. Unlike other small-business loan options, unsecured business loans allow you to borrow without pledging real estate, equipment, or other personal or business assets as a guarantee.
“An unsecured loan can provide essential financing for a business that is facing a crisis or an opportunity,” says Gerri Detweiler, credit expert and co-author of “Finance Your Own Business: Get on the Financing Fast Track.”
Types of unsecured small-business loans include:
Term loans. Your small business receives a lump sum upfront and repays it, with interest, at fixed intervals over a set amount of time. Term loan uses include purchasing equipment or inventory, meeting payroll, and funding working capital, among others.
Short-term business loans may be available, but they can be challenging to get if you have shaky finances or your business lacks credit history.
Business lines of credit. These unsecured revolving lines of credit work similar to credit cards. You can borrow up to a limit and will be charged interest only on the funds you withdraw from the account. A business line of credit can help you meet short-term needs, such as funding working capital, filling in cash flow gaps or growing your business.
Riskier Unsecured Financing Options
Invoice financing: This can be a solution for small businesses struggling with cash flow because of unpaid invoices. With invoice financing, you sell your unpaid invoices to a lender for quick access to cash and typically get about 80% of what the invoices are worth. The lender will then seek payment for the full value from customers.
Beware invoice financing fees. While invoice financing is easy to secure, the fees can add up quickly. Carefully consider the costs to decide whether it is worthwhile.
Merchant cash advances: A merchant cash advance, or MCA, gives you a sum of money for a portion of your forecasted sales. You will repay the advance, plus any fees, as a percentage of your future credit and debit card sales, deducted daily or weekly until the amount is repaid in full. Because these advances have interest rates that can hit triple digits, they are often not a sound choice.
Banks or credit unions may offer unsecured term loans or business lines of credit, but you’re most likely to find an unsecured business loan from an alternative lender. Alternative lenders are typically financial technology firms, or fintechs, that use automated technology to determine your creditworthiness, and some may charge higher interest rates than traditional lenders.
Using an alternative lender is usually better than turning to credit card debt, says Phillip Russo, business consultant with the Louisiana Small Business Development Center at the University of Louisiana at Lafayette. Alternative lenders can also have less red tape than commercial lenders.
“The application process is usually easy, fast and does not impact your credit score,” Russo says. “Typically, the loans are unsecured and can accommodate small startup expenditures and working capital.”
Identifying the best unsecured business loan requires paying attention to factors such as the lender’s eligibility requirements, loan options, costs and customer service ratings.
- Eligibility requirements: Don’t waste time and money with a lender that won’t approve your application. Check criteria for minimum credit score, annual revenue and time in business. Most lenders require at least two years in business, and startups can expect strict scrutiny of their creditworthiness and projected annual revenue.
- Unsecured loan options: Make sure the lender offers the loan type, loan amount and term length you need.
- Costs: Carefully review all costs as you shop for a loan, including interest rate, down payment and origination fee.
- Customer service ratings: Read lender reviews and check the Better Business Bureau for complaints. Contact your state attorney general’s office to verify that the lender is authorized to originate loans where you live.
Benefits:
- You don’t need to provide collateral.
- You won’t risk losing your collateral because the loan doesn’t require it.
- You can get funding quickly because unsecured loans have short approval times – sometimes as little as one day. Approval for other forms of financing, such as a secured business loan or a Small Business Administration loan, could take a month or longer.
Drawbacks:
- Higher interest rates and shorter repayment terms can be expected with unsecured loans for lenders to justify the risk of financing without collateral.
- Loans could be harder to qualify for without collateral. Your business credit score and annual revenue as well as financial statements, business plans and cash flow projections will be scrutinized.
- Lenders may require a personal guarantee, which means you will repay the loan with your personal assets if the business can’t cover its debt payments.
- Amounts may not be as large as you need because lenders tend to approve smaller loans to avoid risk.
If you are in a rush to get business financing, you might miscalculate the right loan amount for your budget or make other errors. Exercise these precautions to prevent costly mistakes when taking out unsecured business loans:
Craft a thorough business plan.
Writing a detailed business plan is essential to getting any type of business loan. The lender will look carefully at the strengths and weaknesses of your business, including your credit trade lines with other businesses, business bank account statements, profit margins, and revenue projections.
Get your personal finances in order.
Your personal finances often come into play when you are being considered for an unsecured business loan. A high personal credit score can help you secure a loan.
Check and improve your personal and business credit scores, if necessary, before you apply for an unsecured business loan, Detweiler says. While you might qualify for financing with a low minimum credit score, you will have better, more affordable options with good credit.
Plan how you will use the funds.
The purpose of the loan should fit the duration and type of loan. For instance, an unsecured business line of credit can be an appropriate option to provide capital for short-term expenses, such as payroll, while waiting for customers to pay. A term loan for equipment that will be paid off in three to five years, when the equipment life has expired, is also an appropriate type of financing.
Prepare for a short repayment period.
Carefully assess your company’s profitability and cash flow. Do the math and make sure you can manage the loan payments.
Before getting an unsecured business loan, evaluate the costs and the benefits. On one hand, you won’t need collateral and can be approved quickly. On the other hand, unsecured business loans are typically costlier for borrowers compared with secured loans: Expect higher interest rates and personal guarantees.
If an unsecured business loan doesn’t fit your needs, you could consider a secured line of financing as long as you have collateral to offer. You could also explore creative financing options for your small business. That can include crowdfunding, asking friends and family members for a loan, or using a co-op business structure, which allows investors to have a say in decisions and share profits.
Unsecured business finance options work like traditional small-business loans, except that you aren’t required to put up collateral. Not every borrower can put up collateral for a small-business loan.
Many alternative lenders make small-business loans that don’t require collateral. Instead, they provide unsecured loans based on the creditworthiness of you or your business.
Because of stricter regulations, getting an unsecured business loan can be difficult. Qualifying for the loan depends on the lender and the financial strength of the business applying for the loan. Lenders take into consideratio the age of the business, its revenue and the business credit score, along with other factors, to determine if the loan will be granted.
Merchant cash advances, revolving credit facilities, business overdrafts and business credit cards are all examples of unsecured business loans.