In financial terminology, collateral refers to items that a borrower pledges to help secure a loan. When applying for an SBA loan, collateral may include business assets, real estate, equipment, inventory, or, in some cases, personal property.
Unlike an unsecured loan, loans backed with collateral give the lender an option in the event of a default. If you’re about to apply for an SBA loan, understanding how collateral works may allow you to set realistic expectations as you get the funds that you need for your business.
What collateral means for SBA loans
Lenders view collateral as a security measure that provides them with some sort of return on their loan if the borrower defaults. Typically, when a loan goes into default, the lender tries to liquidate some of the assets that were used as collateral. As a partial guarantor, the SBA is an interested party in this process.
Lenders typically don’t try to seize assets until there has been no payment activity for 120 consecutive days. If you obtain a collateral-backed SBA loan and run into problems with repayment, contact your lender as quickly as possible. In many cases, lenders will work with you to help you avoid going into default.
Why SBA loans often require collateral
SBA loans are popular, largely because the SBA (Small Business Administration) guarantees a percentage of the loan. While this does offer the lender some breathing room, there are still risks associated with lending money. Collateral helps offset those risks, which makes it easier for banks to lend money to small businesses. Not only does this make more applicants eligible to receive funding, but it also helps keep interest rates low and makes it possible to offer longer terms.
Collateralized loans also encourage responsible decisions for both lenders and borrowers. By securing loans with assets, lenders may be able to extend more favorable terms while still adhering to underwriting standards. This balance supports increased access to SBA loans without eliminating lender protections.
Do all SBA loans require collateral?
Not every SBA loan requires collateral, but most require some form of security. The SBA and individual lenders need to have some sort of assurance that they’re going to recoup the money that they lend small business owners. For example, if your business has a proven history of strong cash flow, a lender may not require collateral. This is especially true if you have a strong credit history, both personally and professionally, or if you’re requesting a small loan. However, for larger loans or loans being requested by businesses that lack proven financial success, collateral is typically required.
It’s important to note that SBA guidelines prohibit lenders from declining an otherwise eligible loan solely due to insufficient collateral. While collateral strengthens a file, a lack of collateral does not automatically prevent loan approval.
Collateral requirements by SBA loan type
The SBA offers a variety of loan options for small business owners. Each type has its own set of regulations that cover the maximum amount that can be lent, minimum requirements, and collateral. Consider the amount and type of collateral required for different SBA loans, in addition to how much money you need and what you intend to use the funds for.
SBA 7(a) Loans
SBA 7(a) loans are the most common type, thanks in large part to their low interest rates and lengthy repayment terms. However, these loans typically involve some collateral. Lenders typically secure loans with business assets such as equipment, inventory, and accounts receivable. For 7(a) loans above certain thresholds, real estate may also be required if owned by the business or borrower.
SBA 504 Loans
SBA 504 loans are inherently collateralized because they are typically used for real estate or major equipment purchases. The assets being purchased with the funds from the loan usually stand as the collateral. If the borrower defaults on the loan, the lender seizes ownership and then liquidates the asset.
SBA Microloans
SBA Microloans are smaller-dollar loans typically issued by nonprofit intermediaries. Collateral requirements vary by lender but are often more flexible than traditional SBA programs. Some microloans may function similarly to unsecured loans, depending on the financial strength of the borrower.
Since microloans are for smaller amounts and are typically only offered to startups and early-stage businesses, the underwriting process usually focuses more on business plans, cash-flow projections, and management experience.
What happens if you don’t have enough collateral
Unlike some types of personal loans, SBA loans are not always contingent on collateral. In fact, even if you don’t have enough collateral to cover the value of the loan, some lenders may continue with the approval process. Lenders may require applicants to show strong cash flow and credit reliability to obtain a loan with no collateral. This approach supports broader access to business lending.
Lenders have some leeway when no collateral is available. They may adjust the loan structure, lessen the loan amount, or require additional documentation. While collateral matters, it is only one factor in the overall loan approval process.
The role of personal guarantees
Generally, SBA loans require personal guarantees from owners who hold a significant stake in the company. While a personal guarantee is not the same as collateral, it does hold borrowers individually and separately responsible for repaying their loans. In most cases, any individual who owns 20% or more of the business is required to personally guarantee the loan. This means the lender can pursue the guarantor’s personal assets if the business is unable to meet its loan repayment obligations.
Personal guarantees are common across small business loans, especially when businesses are owned and operated by one person or a small group of partners. While collateral ties the loan to specific assets, a personal guarantee extends responsibility beyond the business itself. This added layer of protection helps lenders approve commercial loans for small businesses that may not have enough hard assets to fully secure the loan on their own.
If you’re a small business owner, it’s crucial to understand personal guarantees before signing an acceptance letter. A guarantee increases your personal financial exposure, which makes them riskier for business owners. However, the use of personal guarantees is at least partially responsible for SBA loans being more accessible than traditional financing options.
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FAQs
How much collateral does the SBA require?
There is no set dollar amount of required collateral when applying for an SBA loan. Instead, lenders may seek an appropriate amount of business assets and, in some cases, personal assets. Generally, not having enough collateral to match the value of the loan does not disqualify an applicant from receiving an SBA loan.
Can I get an SBA loan without collateral?
Yes, you may be able to get an SBA loan without collateral. If you’ve been in business for a while and you have a strong financial history, many lenders will waive any collateral requirements. Even if your business is relatively new, you may be able to get a loan without collateral, though you may need to apply for a smaller loan or provide proof of strong financial standing.
What types of assets can be used as SBA loan collateral?
Collateral may include commercial real estate, equipment, inventory, accounts receivable, and, in some cases, personal property. The specific assets depend on the loan type and lender policy. These assets help secure collateralized loans within SBA programs.
What happens if I don’t have enough collateral for an SBA loan?
If you have limited collateral, lenders may still approve your loan application. However, you’ll need to prove that your ability to repay the loan is strong. This can include personal and business credit scores, strong financial projections, and personal guarantees.
