This is what you can use as collateral for a business loan

13th September 2023 update

In a significant move to bolster small businesses across the United Kingdom, the UK government has allocated £1 billion through its Start Up Loans scheme.

The government website also notes that successful applicants will receive free support and guidance to help write their business plans, and up to 12 months of free mentoring.

To apply for a government-backed Start Up Loan of £500 to £25,000 to start or grow your business, click here.

Small businesses need constant access to business capital in order to grow. In fact, it has been said that the average UK business needs around £22,000 just to survive its first year in order to cover overheads such as office rent, staff and inventory.

Some entrepreneurs will use their own savings to fund a business and some will take out an unsecured personal loan or government grant; the challenge is having sufficient capital to stimulate growth. For many start-ups and small businesses, using some form of collateral is the best way to secure the funds they need.

For those lending to businesses, having some form of security or collateral means that their risk is heavily reduced, because they are able to recoup a physical asset and sell it in order to recover their costs. Below, we discuss the different types of security and collateral available for small businesses.

Property

This is probably the most common form of collateral used since property is likely to be valuable and increase in price over time. The lender can potentially re-sell the property for a higher price than at the beginning of the agreement and recuperate their costs.

For property developers and investors looking to renovate a building for resale or buy-to-let, securing finance on the property is very common.

Individuals can secure the loan for their business on the property where they live. However, this is considered a high-risk approach as you face repossession of your home if you cannot keep up with repayments.

Other options come in the form of a second charge loan, which is a second mortgage on your home. You typically borrow slightly less than your first mortgage – because now the lender is second in the queue when it comes to prioritising your repayments – but this is a common way to raise money for business purposes.

Cash

This is a less common form of collateral and involves applying for a loan in a bank or financial institution where your account is based. In the event that you default on payment, the lender can liquidate your account. This is less practical because if you are behind on repayments the likelihood is that you will not have any money in your account anyway for them to liquidate.

Inventory financing

If your company owns a lot of inventory or stock, you can it as collateral in order to raise finance. In this case, if you do not keep up with repayments, this inventory can be repossessed by the finance provider.

This can be applicable for manufacturers who are likely to own machines, computers and materials or restaurants that have furniture, appliances and food products. Even schools and hospitals that own equipment can use it as a form of collateral to raise funds.

Invoice finance

There are certain businesses which tend to have a lot of unpaid invoices outstanding and this is common in industries such as construction, catering and fashion retail. If you know that you have £100,000 worth of unpaid invoices that will be paid in the next year, you can use this as collateral in order to borrow even more money. The lender will then be eligible to retrieve these outstanding invoices in the event of arrears.

Guarantees

Although not technically collateral, business owners can gain extra security on their business loan by having another individual or company be their guarantor. This means that if the main borrower defaults, the lender can request funds from the person or company that has agreed to guarantee repayment.

Having guarantees in the contract is very common, especially for new businesses with little track record or if there is just one company director with an adverse credit record. The business owner can also apply for guarantor loans through consumer finance, allowing them to borrow up to £15,000 over 7 years and then invest this into the business.

Mezzanine finance

This type of finance is a combination of equity and debt that gives the loan company a larger percentage of the business due to the potential risks, but also offers greater rewards. This is a financial product that is commonly offered by secured lenders and there is scope to get more equity in the business if the borrower does not keep up with repayments.