There are many ways to fund a new business and raise money as it grows. A small business loan can be essential in helping you make those crucial next steps, but navigating all the different options can feel daunting. Whether it’s for staff wages, upgrading the cafe coffee machine or taking those first steps to getting a business off the ground, we’ve broken down the main differences between secured and unsecured business loans.
If you’re a homeowner, the chances are you’re familiar with the classic example of a secured loan: a mortgage. This type of loan gives the lender security by using an asset – whether it be machinery or a property – as collateral if the business owner fails to repay the loan.
“It involves the granting of some form of security to the lender,” explains director of FRP Advisory David Shambrook. “The effect of that security is to say that should the borrower become insolvent and unable to repay all of its debts in full and on time, the lending institution is the first to receive repayments over that secured asset.”
The main requirement for being granted a secured business loan is having something that can act as security. This means already owning an asset – such as a personal property – or borrowing against the asset you’re about to buy – such as the premises for your new clothing brand.
The amount that can be borrowed, the term, and the interest rate will vary depending on each business owners personal circumstances. In general, because that risk is lower for the lender it means they tend to be more willing to be flexible with the amount they lend and will allow for longer time periods over which repayments can be made.
The main difference between secured and unsecured business loans is that there typically isn’t such a level of legal security for a lender, meaning the risk or exposure for them is much higher.
Providers of unsecured loans tend to mitigate this risk by lending smaller amounts over shorter periods of time. A seasonal business – such as a B&B with a focus on summer tourism – might seek an unsecured loan to cover gaps in their working capital (such as staff wages) in months when business is slow, knowing they can pay it back once things pick up in summer.
A lender will often loan an amount based on the business’ turnover, estimating the future success of the business based on its past performance. Generally, it's also common to provide a legal loan document, explains Shambrook. “This will typically say how much has been lent, what the interest is to be paid, the installments of repayments, and the terms if they default,” he says.