The Pros and Cons of Unsecured Small Business Loans
The choices involved in small business financing can be confusing for a commercial borrower. One concern is determining whether to use secured or unsecured financing. To help you get started in making this important decision, here is an overview of the advantages and disadvantages of unsecured small business loans.
Pros — Advantages of an Unsecured Business Loan
Many successful companies rely on unsecured commercial financing because it offers advantages such as the following:
- It's faster to obtain due to less loan processing time, which can even be shorter than a week in some cases.
- You don’t need to pledge collateral. This is even more important if you don’t have collateral.
- Bankruptcies often discharge unsecured loans. Secured financing is usually not discharged.
- It precludes the need for equity financing and helps you maintain your ownership position.
- It provides flexibility for a growing business and supplies working capital when you need it.
- It can help build a repayment history that facilitates future financing as well as build a business credit history.
- You can avoid the need to rely on personal financing, eliminating the use of family and personal assets.
- There are usually fewer restrictions on how your company can utilize the borrowed money, which gives you more choices in how you spend the funds.
It can be helpful to look at the above advantages as a business loan checklist. Make a note of how many advantages are important to you. While you only need one strong reason to choose this method of financing, it is not unusual for business owners to find five or more solid benefits.
Cons — Disadvantages of an Unsecured Commercial Loan
In any business decision, it is prudent to examine the potential disadvantages. With unsecured business loans, you should consider the following factors:
- There are shorter periods for repayment and higher monthly payments. Unsecured business loans are usually short-term and must be repaid more quickly.
- Loans frequently involve smaller amounts. Unsecured business financing might not be available for larger commercial loans.
- It can involve higher financing costs. You should consider your internal rate of return.
- Credit scores and creditworthiness are more important. Without collateral, lenders will usually look at credit factors more closely.
For your business and personal circumstances, do the pros outweigh the cons? If you’re not sure, don’t hesitate to ask for a second opinion from your accountant and other financial experts. Make sure you tell them what you need funding for and how quickly you want to secure the financing. Ask them what your realistic choices are.
The Bottom Line: What Is Best for Your Business?
Once you have reviewed the pros and cons of unsecured commercial financing, one of the best ways to put everything into perspective is to discuss a “real-life example” with one or more prospective lenders. For example, you will discover what is actually possible for your specific business situation, including how much you can borrow and how quickly.
Your most prudent alternative will not always be an either/or decision. In many cases, your best decision could involve a combination of secured and unsecured financing.
Before you apply for a loan for your small business you need to prepare yourself – using a business loan checklist will help you prepare what you need before you apply