When it comes to financing a business, you can either go down the route of choosing an unsecured loan or a secured loan.
Both are valid options for a small business who could find it a challenge raising the necessary funds to achieve its objectives, but it’s important to be informed about the differences between the two business finance options.
Ultimately, there’s no right or wrong answers on financing a business – the route you take will depend on factors such as your cash flow, business capital, company objectives and personal risk mindset.
Secured vs unsecured loans
Secured business loans
A secured loan, sometimes called asset-backed lending, is typically available from banks and is sanctioned on the agreement that the funds are backed up by security, usually valuable assets and items that your business owns.
This means that you borrow a set amount and if you don’t keep up with loan repayments, you could lose your asset. Obviously, the assets that are secured against a loan depends on the nature of your business.
Having to potentially give up assets in the case of being unable to keep up with loan repayments might be seen as too much of a risk by some. There are also hefty administration fees to pay before you get the loan – much like when applying for a mortgage – which might be considered a disadvantage.
On the flipside, a business can typically borrow more money with a secured loan, usually up to around £125,000, and you’ll be given a longer stretch of time to pay it back. The length of the agreement usually means that repayments are manageable, as interest rates are low, and can be suitably budgeted for, which is crucial for a small business where maintaining healthy cash flow can be a challenge.
As you might have already deduced, unsecured business loans aren’t backed up by any business assets. While this can sound appealing to borrowers, lenders, as you would anticipate, find ways of insuring against their risk.
So, you’ll typically have to pay more interest with unsecured loans. That’s if you manage to access an unsecured loan in the first place. Often, unsecured borrowings are required when the business doesn't have assets to support "secured" positions, or other lenders have already "taken" the secured position (i.e. business assets).
An unsecured business loan, then, is a viable option if you only need a small amount such as £20,000. But you’ll want to ensure that the time you are given to repay the loan by the lender is not too short – the longer the loan period, the lower the interest rate you’ll be charged on the loan.
What if you’re asked to sign a personal guarantee?
Unsecured borrowing is almost always supported by a Personal Guarantee, and it’s common for lenders to ask for personal guarantees to act as security against a secured loan too. Personal guarantees give the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. In practice, this means that if the business defaults on a loan (or lease), the director’s home, car and anything in their personal bank account may be at risk.
Your spouse or partner will have to sign the guarantee if they co-own the family home, so it’s vital you seek sound legal advice before making such an important commitment.
Most guarantee forms require joint and several liability. This means that each individual who signs a guarantee can be liable for the whole amount of the loan.
Make it a priority to find out what signing that guarantee means for you personally, and if it is the only way you can realise the objective of financing a business, consider taking out insurance to cut the risk of financial loss.
Currently there’s only one insurer offering personal guarantee insurance to small business owners, which can be purchased for an existing guarantee, or as finance is taken out. Cover provides up to 60 per cent of the debt value in year one, rising to 70 per cent in year two to a maximum of 80 per cent in year three, and premiums can be flexed depending on the policyholder’s credit rating. Throughout the policy the small business owner also has access to specialist business advisers.
Contact Purbeck today to find out your cover options.