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Key Points:
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Unsecured business loans don’t require assets as collateral.
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Depending on your business, loan types include government-backed loans, invoice factoring, merchant cash advances, and more.
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Business loans can be used for various business costs but not personal expenses.
Starting or expanding a business is tough. Private debt is cumbersome, private equity reduces your stake, and business credit cards have high-interest rates. Unsecured business loans offer flexible financing for entrepreneurs without the pitfalls of traditional business capital-raising options.
Unsecured business loans - offers entrepreneurs flexible business financing.
What is an Unsecured Business Loan?
An unsecured loan is a type of loan that does not require collateral, while a secured loan requires an asset as collateral. Secured loans include mortgage, car note, and margin trading, which use your home, vehicle, and stocks as collateral. Unsecured business loans are ideal for businesses without many physical assets but usually have higher interest rates and stricter repayment terms.
How Does an Unsecured Business Loan Work?
Unsecured business loans work similarly to any other loan. If you apply for unsecured business financing, the lender reviews your file, and (contingent on loan approval) you get the funds and repay the loan according to the repayment schedule and terms. But, since the lender isn't examining asset value for collateral, unsecured loans typically fund more quickly than secured loans.
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Types of Unsecured Business Loans
Your specific cash needs and business will drive the type of unsecured loan that’s best for you. Common unsecured loans include:
Term Loans
Most borrowers think of this when they envision an unsecured business loan – you draw funds as a lump sum and pay the lender back according to the agreed-upon terms.
Business Line of Credit
A business line of credit is a revolving credit account, like a credit card, wherein the lender authorizes a maximum amount of money available to borrow. You can borrow up to that limit, using as much or as little of the preapproved funds as your business needs. You pay the loan back like you do a credit card - on an installment basis, paying back the amount borrowed plus applicable interest.
Merchant Cash Advance (MCA)
This option is popular in retail sectors. When you get an MCA, the lender offers a loan as a lump sum, and you pay it back by automatically allocating a percentage of your business sales to the creditor. Instead of an interest rate, fees are calculated by factor rate. Factor rates usually range between 1.2 and 1.5; if your factor rate is 1.2, you’ll pay $1.20 for every dollar borrowed.
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Peer-to-Peer (P2P Lending)
P2P lending platforms act as matchmakers for borrowers to get funding from individual investors or groups pooling their money together. Terms and interest vary for these types of loans, including installment plans and balloon payments.
Invoice Factoring
If your company relies on receivables with a long payment period, as we discussed above, invoice factoring lets you borrow against the unpaid invoice or future promised payment. Invoice factoring loans don't usually use interest rates; instead, you'll borrow a percentage of the invoice and pay the entirety back upon payment.
For example, if you have an outstanding net-90 invoice worth $1,000 (meaning you don't require payment for 90 days after invoicing), you might borrow $800 today under invoice factoring and pay the lender $1,000 when your client settles their account.
Small Business Administration 7(a) Loans
Also known as SBA 7(a) loans are government-supplied lending opportunities that offer up to $50,000 as unsecured loans. These loans have stricter lending criteria and longer funding timelines but offer lower rates when other options are not available.
What Can I Use an Unsecured Business Loan For?
You can use an unsecured business loan for many purposes, provided they’re related to your business. This means that if you're borrowing as a business entity, you can't use business financing for personal expenses or debt.
Suppose you’re a single-member LLC or sole proprietor and tend to intermingle your funds. In that case, it’s best to consult with a finance professional before borrowing to help develop specific barriers that limit the possibility of using loan funds improperly.
Some lenders also exclude certain business categories, like gambling, adult entertainment, financial services, and multi-level marketing, from unsecured business lending.
Beyond those restrictions, the possible uses for an unsecured business loan are wide-ranging:
Start-up Expenses
Getting a new operation off the ground and running can be expensive, especially if you aren't generating revenue yet. Likewise, if you're beginning, you likely don't have many assets to borrow against or creditworthiness. An unsecured business loan can help boost your new venture without draining your personal funds.
Acquisition and Expansion
If you want to buy a competitor or expand rapidly, an unsecured loan lets you close the deal faster than saving retained earnings or negotiating owner financing.
Debt Consolidation
If you borrowed money for your business through multiple loans at different times, you may have different interest rates and payment schedules. Consolidating them into one unsecured business loan can help you manage your debt more easily and predictably. This can also save you money in the long term if the new loan terms are better.
Inventory
Some businesses are cyclical, meaning they have predictable sales seasons. For example, some retail companies sell tons of inventory during the winter holiday season, but sales stagnate in summer. If you're getting ready for a busy season and need to buy more inventory, but don't have enough money to do so during slower periods, take out an unsecured loan. This can help you bridge the gap between buying inventory and making sales.
Equipment
Borrowing is customary for small business owners who don't want to allocate their capital to large assets. These loans are generally asset-backed since equipment acts as collateral. You can also explore unsecured loans as an alternative to faster funding if you have a high credit score.
Daily operations
Sometimes, you want to maintain a healthy cash buffer, or you might be in a cyclical industry like we mentioned above. In these cases, you might draw an unsecured loan to help pay for daily expenses like lease costs, utilities, payroll, and similar costs. Likewise, if your company's balance sheet is heavy on receivables that you don't convert to cash quickly, an unsecured loan can help cover the difference between invoicing and payment.
Advantages and Downsides of Unsecured Business Loans
As with any debt instrument, you face risks and downsides to using unsecured business loans. But, if you carefully manage your finances and ensure you operate within the appropriate legal parameters, the benefits can easily outweigh the drawbacks.
Advantages of Unsecured Business Financing
- Speed: Since your lender isn’t valuing existing assets as collateral, funding is usually faster than secured loans.
- Growth: An unsecured loan offers a large amount of money to grow your business.
- Variety: There is a range of available loan options, and many lenders offer these (and more) unsecured business loans. This means you can usually find an unsecured business loan with reasonable terms that match your business needs.
Drawbacks to Unsecured Business Loans
- Personal risk – even if you operate as a corporate entity, some lenders require personal guarantees as a borrowing precondition. This means you agree to forfeit personal assets if you default on the loan. Personal guarantees don't make it a collateralized loan. The personal guarantee isn't related to a specific asset – asset seizure is up to the lender's discretion.
- Higher costs – since an unsecured loan represents greater risk to the lender, you'll usually face higher interest rates than an asset-backed loan.
- Lower lending amounts – You can't borrow as much on an unsecured loan as you could through asset-backed financing.
Bottom Line
Sourcing capital is stressful, especially when you must put your assets and livelihood on the line for a secured loan. An unsecured business loan can be an option if you need funds, have long invoice cycles, or cannot offer collateral.
Be careful – borrowing too much, too quickly, at unfriendly terms has the same risk for unsecured business loans as any other debt type. Determine the best loan option for you, budget for payments, and ensure you're putting the money to work to generate a return for your operation beyond the borrowing costs.
FAQ
Can I use an unsecured business loan for personal expenses or debt?
No – all business loans, unsecured or otherwise, must be used for your business. If your personal and business finances tend to intermingle, work with a financial professional to determine whether you can safely use unsecured financing options.
Can I get business financing with a bad credit score?
Unsecured business loans tend to be more forgiving than personal loans, meaning you might qualify even with a bad credit score. And, since many lenders offer unsecured loans, you should be able to find one willing to work with you despite a bad credit score. Watch out, though – if you have a bad credit score, your interest rate will likely be higher and your borrowing amount lower.
Are unsecured business loans the only business financing option?
No. You can also get secured loans using existing assets as collateral, use a business credit card, and explore equipment financing options.
Article Topics
Business Loans
Jeremy is a finance and investment writer who works with stock research platforms, wealth managers, and investment funds to deliver value to clients and customers. He couples his lifelong interest in financial topics with an MBA from the University of California - Davis, and loves breaking down complex topics to educate new and experienced investors alike. He lives in Austin, TX with his wife and young son.
