If you are trying to get a business loan from a traditional bank you are going to need collateral. If you are going to try to get an SBA loan you will need to pledge your home as collateral if you have a home. It is simply SBA policy, they always require that the business owner pledge their home as part of the loan collateral. There are really two questions related to collateral:
- Why does the bank need collateral?
- How much collateral will they require?
The idea of collateral is nothing new. The bank wants to give you an incentive to pay back the loan. If they did not hold your assets as collateral, you could simply fail to pay back the loan and really not lose anything other than your credit score. Many borrowers already have tarnished credit scores, so that is rarely enough incentive to base a loan on. SO the bank is going to require collateral that is worth more than the amount of the loan. So you will actually lose more than you will gain by not paying back the loan.
The SBA (Small Business Administration) always requires that a business owner pledge their home (if they own a home) because they do not want to waste tax payer money on making bad loans. The SBA wants to make sure that the business owner is fully committed to the success of the business, and is willing to risk even their home. They figure that if the business owner is not willing to risk their home, then why should the American tax payer risk their hard earned money to fund their business? Makes sense right?
Now the thing that really surprises and frustrates most entrepreneurs is how much collateral the bank is going to ask for.
Unfortunately, you are not going to get away with 100% collateral. You can’t buy a piece of equipment for $50,000 and hope to get a $50,0o0 loan with only the equipment as collateral. Depending on the type of asset banks will lend some percentage of the value of the asset. This is called Loan to Value which is explained in more detail here. Here are the 4 primary assets that you can secure a business loan for and the loan to value percentage that the bank will be willing to lend with.
- Commercial Real Estate – 70% to 75%
- Inventory with broad market potential – 50%
- Inventory with specialized market – 0%
- Equipment – 50% to 60%
- Accounts Receivables – Depends on the credit worthiness of your customers, but can be up to 80%
This just gives you a place to start. Obviously the details matter on any loan application, so these numbers just give you an idea of how much of a loan you might expect based on the value of various types of assets.