To some small business owners, the ways that lenders evaluate a loan application are almost a total mystery. However, there are some fairly basic and rudimentary ways that a lender will often consider your loan application. Some of these relate to common-sense elements of lending, or, in other words, assessing risk by looking at what resources the small business borrower may have. The evaluation of these resources gets funneled into a greater equation that the lender hopes will give them an accurate picture of how likely it is that the borrower will be able to repay the loan.
Collateral – A Major Factor in a Small Business Loan
When it comes to “proving yourself” to lenders, collateral is king. Many lenders view collateral as almost as good as money in the bank. The trick is that only certain kinds of assets usually qualify as collateral, and some of these need to be used on a loan application in specific ways.
One of the first considerations is what qualifies as collateral for the average small business loan applicant. In general, real estate is eligible for use, so either a home or investment property can be part of your collateral package. However, two disclaimers affect most small business borrowers: one is that the property must be free of liens and must have a certain amount of existing equity. The second is that many lenders do not qualify land without buildings on it, or they may value this collateral at a lower percentage of its cash value.
Other Collateral for Small Business
Most small business owners would think of owned real estate as a major asset, but some might end up scratching their heads over what else can qualify as collateral. One big hint is that anything that provides value in your current business is up for consideration, though certain limitations apply. For instance, held inventory can, in some cases, be seen as good collateral. That means the unsold products in your warehouse could get you some additional backing for a loan (although not a lot). Another big opportunity is in valuing the equipment that you own and use for business, or even equipment that you don’t own but have major equity in.
Thinking creatively, some small business owners can come up with even more interesting ways to pump up a loan application. In some cases, for example, a purchase order can augment a loan app, if the order shows that the business has an ability to use loan funds along with existing infrastructure to quickly fulfill the order and meet a revenue benchmark.
Ways to Pin Down Collateral
One of the best ways to use the collateral that you have is to fully document the value of your existing assets. What you paid for your assets isn’t going to be applicable unless you can provide solid proof of the underlying value. There are different ways to do this according to the type of asset, but learning about valuation in more detail will ultimately help you present a better loan application.
Another way to accurately identify collateral is with a two-pronged approach of adding up cash and equity. When it comes to proving value or a business “net worth,” cash is best. There’s no arguing with a cash total. But when it comes to equity, the small business owner might need to rely on other professionals to get that detailed information into the loan application.
Think about all of the above as a way to successfully arrange a business loan when you need additional money for operations. As experienced pros point out, most lenders require a borrower to have a certain percentage of money down, to have some “skin in the game,” and collateral is one of the most straightforward ways of fulfilling this requirement.