Collateral

Collateral is an asset pledged to secure a loan. If the borrower stops making payments, the lender has a legal right to seize the collateral and sell it to recover the debt. Common forms of collateral for small business loans: equipment, inventory, real estate, vehicles, and — through a personal guarantee — the owner’s personal assets (home, savings).

Collateral reduces the lender’s risk, which is why secured loans carry lower interest rates than unsecured loans. A $50,000 equipment loan secured by the equipment itself might carry a 7% rate; the same amount unsecured might be 14% or unavailable entirely.

The loan-to-value ratio (LTV) determines how much a lender will lend against collateral. A lender offering 80% LTV on a $20,000 piece of equipment will lend up to $16,000 against it — because if the borrower defaults, the equipment’s resale value may be less than its purchase price.

Personal guarantee: When the business’s assets aren’t sufficient collateral, lenders often require the owner to personally guarantee the loan. This means the owner’s personal assets — house, car, savings — are on the line regardless of the business’s corporate structure. An LLC normally protects personal assets from business liabilities, but a personal guarantee pierces that protection for the guaranteed debt. See Financing and Debt Management.