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Secured vs. unsecured loans

One of the simplest ways to distinguish between business finance products is to see whether or not the lending is secured. You’ll often hear lenders — and the team at Funding Options — talking about ‘security’ for business loans, and although it’s a simple idea, it’s crucial to all types of business finance. On this page we’ll look at secured vs. unsecured loans, the differences between using security and getting an unsecured business loan, and what it could mean for your business.

Secured business loans

A secured business loan is backed up by security, usually valuable assets and items that your business owns. Secured lending is often known as asset-backed lending — because it’s business lending backed by assets.

Usually, assets refers to tangible items like commercial property, machinery or vehicles. There are other types of secured lending though — for example invoice finance uses accounts receivable. There are also products like merchant cash advances which, although based on card terminal sales, are technically unsecured.

Examples of secured lending

  • A business looking to raise money to buy a competitor secures finance against plant machinery and commercial premises — with a much longer repayment term than would normally be available.
  • The director of a company using their residential (i.e. private) property to secure a loan for their business
  • Invoice finance: because it’s related to the value of the invoices your business has raised (i.e. money owed to your business), it’s technically secured lending

Unsecured loans

By contrast, unsecured business loans aren’t backed up by any asset. That means there’s a higher risk for the lender — as they have no guarantee of getting their money back — so you’ll generally pay more interest with unsecured loans.

They also tend to be for smaller amounts, and take place over a shorter period of time. For these reasons, most alternative business finance is secured against something.

Unsecured business loans are normally backed up by a business’s trading position. For example, it’s common for lenders to specify the loan amount as a multiple of turnover — that way, they can make a fair estimate on your business’s future, based on how it has done in the recent past.

Alternatives to offering security

Unsecured loans normally require background and credit checks, where the lender looks at the Director’s track record as well as that of the company. It’s also fairly common for lenders to ask for personal guarantees for larger unsecured loans.

Most of the time, large unsecured business loans are only an option for businesses with a strong cashflow position. From a lender’s point of view, the ideal candidate for this type of setup is a company that has a long trading history, provable growth, and a balance sheet that shows they can easily afford repayments. Unfortunately, this is a difficult thing for many early-stage and small businesses to fulfil.

Why would you want an unsecured business loan?

Either because you want to borrow more than your assets are worth, or because you’d prefer not to offer specific assets as security.

The mainstream banks are typically willing to lend high amounts in secured loans if the business has appropriate security to offer, but on the other hand they won’t lend more than about £40,000 unsecured.

From the banks’ point of view, there’s more risk lending to a company that doesn’t have any assets to back up the loan — and even a rock-solid credit rating isn’t enough to persuade the banks to lend more than around £40,000.

Examples of unsecured finance

  • Working capital finance, where a seasonal business wants to cover a lean trading period using a two-month loan — in this example, the company would pay interest per month
  • Short term cash flow loans, with terms normally less than two years
  • Merchant cash advances: similar to invoice finance, but based on predictions of future card terminal sales rather than money already owed to your business

Which type of lending is right for my business?

Because there’s such a wide variety of products in the alternative finance market, we can’t be too specific about whether using security or unsecured business loans is ‘better’ for your business.

Overall, the determining factors are timeframe and cost — do you want the cheapest product possible, or are you willing to pay extra to have the cash fast? And if you want an unsecured loan, does your business have a track record the lender can trust?

Here’s a summary of the pros and cons of secured and unsecured lending:

Secured:

  • Usually cheaper — because there’s less risk for the lender
  • Necessary to have assets in your business, which can be challenging for new companies
  • Requires valuations and legal costs, which often have to paid upfront
  • These due diligence processes also mean it takes more time to get the funds

Unsecured:

  • Usually more expensive
  • Almost always quicker — no valuations are necessary and the legal process is much more straightforward
  • Don’t need to have physical assets in your business
  • Less up-front cost — sometimes none at all
  • Not many businesses have the ‘asset spread’ to secure big loans against — unsecured can be a more accessible type of finance.

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