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Starting a business can seem like a catch-22 situation. Often, lenders won’t give you a business loan unless you can offer collateral—an asset they can repossess if you default. However, with high start-up costs, entrepreneurs usually need financing to get off the ground.
This is when unsecured business loans come in handy. While it’s easier to get one as an established business, it’s not impossible. If you take a little extra time to put together and execute a plan, you’ll likely be able to get the financing you need.
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What are unsecured business loans?
It is difficult to convince a lender to give you money for a business venture. Most of the time, they want to see a demonstrated history of success with strong and consistent revenue. Without it, you’re a riskier candidate.
Lenders sometimes require collateral to reduce the risk of a loan transaction. This means that if you default, they can seize the collateral – whether it’s a bank account, business inventory, real estate, etc. – to recoup their losses.
But with an unsecured business loan, you can get financing that doesn’t require collateral. But keep in mind that because there are no business assets to back the loan, lenders usually have stricter qualification requirements and will require a personal guarantee.
How do unsecured business loans work?
Unsecured business loans help companies make large purchases and cover the costs of doing business. Funds are usually paid out as a lump sum that can be used to make a specific purchase or manage cash flow and are then paid back with interest. However, there are other types of small business loans – such as lines of credit, merchant cash advances and invoice financing – that can be used to access cash more quickly and when needed.
Personal guarantee requirement
If you apply for an unsecured business loan, you will usually be expected to sign a personal guarantee for the loan. It’s not quite the same as pledging property against a secured loan, but if you default, the lender can go after your personal assets to cover what you owe.
Unsecured Startup Loan Options
If you are starting a new business from scratch, you will probably need a lot of money. Here are some of your options for unsecured business loans:
SBA loans under $25,000
If you only need a small amount of startup funds and are not in a rush, a US Small Business Administration (SBA) loan for under $25,000 can be a viable option.
These types of loans usually offer the most business-friendly terms, with lower interest rates compared to other loan options. That’s because a portion is guaranteed by the SBA, so if you default, the lender may be able to recoup some of its losses directly from the government.
SBA loans come in all shapes and sizes. Collateral is usually required for large loans. But if you’re applying for a standard SBA 7(a) business loan, you probably won’t have to provide collateral for loan amounts under $25,000. However, you and any other owners with at least a 20% stake in the business will have to personally guarantee the loan. This means that you legally agree to repay what you borrowed with personal assets if the business does not.
Online startup loans
Traditional financial institutions may not be as kind to startups, but that doesn’t mean other lenders aren’t. It’s relatively easy to find loans aimed specifically at new startups, often from smaller online lenders. Like other forms of alternative small business financing, online loans for startups tend to be expensive, so you’ll need to consider this carefully in your business plan.
Merchant Cash Advances
When you take out a merchant cash advance (MCA), you’ll be paid a lump sum up front, just like a loan.
However, instead of paying it off in steady payments over time with interest, you’ll agree to a factor rate that determines the total amount you pay for the loan up front. You then pay it back as a percentage of your credit card transactions – this is known as a retention rate. These payments are usually made much more frequently – sometimes even daily – than with a typical loan, and you’ll continue to make them until your advance is paid off in full.
For example, if you borrow $10,000 with a ratio of 1.25, you will pay back the lender a total of $12,500 ($10,000 x 1.25). If you assume a 10% retention rate, you’ll pay your lender 10% of all your daily sales until you pay back the full amount ($10,000 you borrowed plus a $2,500 finance charge).
Because your payment amount varies based on your sales, this is an especially good option for businesses with seasonal fluctuations in income or new startups that can’t commit to a fixed monthly payment amount. However, since there is no fixed term length, you cannot easily calculate an equivalent annual percentage rate (APR) and compare it to other lending options. However, they are usually more expensive than standard business loans.
Alternatives to unsecured business loans
Many businesses need multiple sources of financial support to get started. You may need to combine several types of startup funding. Here are some more ideas:
Equipment financing is similar to how car financing works. When you take out a car loan, it’s secured against the car you’re buying, meaning you don’t need to have collateral before you get the loan. Likewise, many small business lenders offer secured loans in the form of equipment financing, with the equipment you purchase acting as collateral for the loan.
While this type of loan won’t necessarily solve your storefront, business inventory, or workforce needs, it can be a good option if you need equipment to get started.
If you have a strong social network, another option to consider is crowdsourcing to raise the funds you need to start your business. This obviously won’t work for everyone; you wouldn’t expect to start a new biomedical company by setting up a Kickstarter fundraiser, for example. But if your business is relatively small, it might be a good choice.
Many people also use their personal savings to help start their business. It can be tempting to raid your emergency savings and/or retirement savings because those are probably the biggest buckets available; think long and hard before you do it though. Make sure you have a plan for what to do if you lose that money.
It’s also a good idea to work with an experienced small business accountant who can help advise you on the most tax-efficient business setup and how to write off your personal investments in the business.
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