Working capital is essential to keep your small business running smoothly. It is the readily available cash needed to meet your immediate and ongoing financial obligations. This includes everything from paying suppliers and employees to managing inventory and handling unforeseen costs. Without sufficient working capital, your business can struggle to maintain its operations and may face cash flow issues that could hinder its success. One viable solution to navigate periods of low cash flow is a working capital loan.
There are two types of working capital loans: unsecured and secured. Unsecured working capital loans do not require any collateral, whereas secured loans are collateralized, meaning they are secured by a valuable asset, such as a home or vehicle. This Huddle Business Capital blog article discusses collateralized working capital loans in detail. We explain what they are, how they work, and more.
What is a collateralized working capital loan?
As we mentioned earlier, a collateralized working capital loan is a loan that is backed (secured) by assets owned by the borrowing business owner. Commonly pledged assets include business equipment, vehicles, real estate, and accounts receivable.
Collateral provides a financial safety net for lenders; it significantly reduces their financial risk. This arrangement ensures that if the business owner fails to repay the collateralized working capital loan on time or defaults entirely, the lender is legally entitled to take possession of the collateral. The lender can then sell the collateral and use the profits to pay off the remainder of the loan.
Due to the serious consequences of losing valuable assets, business owners who take out collateralized loans are motivated to meet their payment obligations and prevent such losses.
Benefits of collateralized loans.
A collateralized working capital loan presents business owners like you with several benefits. Because you are taking on a significant portion of loan risk by pledging collateral, you may be able to access a larger sum of working capital than you might qualify for with an unsecured loan.
Additionally, putting up collateral can lead to more favorable loan terms, including lower interest rates and extended repayment periods. As you know, a lower interest means you will spend less on the money you borrow. Finally, assuming a larger portion of loan risk and repaying the collateralized working capital loan on time can boost your credit score.
Is collateral-based borrowing a good option?
You are not alone if you're wondering if a collateralized loan is right for your business. Many business owners share the same concern. Every business has its own unique financial situation and strategic goals, but here are some scenarios in which collateral-based borrowing is a good option.
Excess debt
Businesses carrying a high level of debt may find collateralized loans a viable option for obtaining financing. These businesses might find it challenging to secure an unsecured loan, and putting up collateral can help them get a collateralized working capital loan.
Robust growth
Businesses that are experiencing robust growth often require an influx of capital to meet customer/client demands and support their expansion efforts. A collateralized working capital loan can be used to hire employees, launch new products or services, and purchase inventory, supplies, and other resources.
Limited credit profiles
Many businesses do not have the credit profiles that traditional banks and lenders typically require for their loan products. However, businesses with limited credit profiles might qualify for a collateralized working capital loan.
What happens to the collateral once a loan is repaid in full?
Once a collateralized working capital loan is repaid in full, the collateral that was pledged to secure the loan is released back to the borrower. This process involves the lender recognizing that the borrower has fulfilled their obligation, which may include a written acknowledgment or release document.
The collateral (e.g., business equipment, vehicles, real estate, accounts receivable) is returned to the borrower without any claims from the lender.
Disclaimer.
This Huddle Business Capital blog article is purely educational and contains general information and opinions; it is not intended to provide advice or recommendations of any kind.
