Being new to the business of commercial lending, I had a rather skewed view of collateral and the importance of it when making a loan. As time has progressed, I not only realize the importance of securing collateral when making a loan, but the absolute necessity of having it. First things first, what is collateral and why is it important for obtaining a commercial loan?
For the sake of sounding too simple, collateral includes any and everything that a lending source can take a security interest in such as equipment, vehicles, inventory, accounts receivable, land and buildings, notes receivable, or investment accounts. Why do lending sources look to obtain security interest in these assets you’re wondering? Glad you asked. In order to minimize their risk of loss in the event of nonpayment of the loan. Just as in our personal lives, nothing in life is guaranteed and no one has been able to forecast accurately the future with any measure of consistency. In order to have a measure of confidence of not only being repaid, but also to cushion the blow in case life happens, banks secure assets as collateral.
The assets you may have to put for collateral have a measure of marketable value depending on its use, age, and resale value. Understanding the value of having collateral is a must for early stage and startup businesses. In addition to becoming cash flow positive as quickly as possible, the second goal for a startup or early stage business is to acquire assets with some ownership interest or at a minimum a controlling interest. Meeting these goals early on will help considerably when making application for a commercial loan. Not only does it minimize business, operating, and collateral risk in the eyes of the lending source, but it also affords you the ability to obtain better terms on the loan.
Jericho Business Advisors provides value added consultation and advisory services for small business owners / operators in the areas of accounting, taxation, and financing.