Plenty of businesses find that, at some point, borrowing money can help them take advantage of opportunities and make it through slower times.
Many financing options are available, but they fall under two broad categories: Secured and unsecured. Secured financing requires an asset as collateral, whereas unsecured financing does not.
To help you pick the best for your needs, this article evaluates five questions to ask when choosing between secured and unsecured business financing. It explores the pros and cons of each and explains what kinds of businesses each could help most.
1. What Assets Do You Have for Collateral?
First, consider what you need to put down for collateral.
Secured financing: A secured business loan requires you to put down an asset as collateral, such as equipment or inventory. The lender can take possession of collateral in case you default, reducing the lender’s risk.
Thus, secured financing may work best if you have assets, you’re willing to risk or are confident you will not miss payments. For example, if you have significant assets and strong cash flows, a secured loan may be a good way to expand your purchasing power to take advantage of sudden opportunities.
Unsecured financing: Unsecured financing doesn’t require collateral. Thus, businesses that want to protect their assets or lack significant assets can access financing more easily. For instance, smaller companies and startups may not have assets to offer as collateral, opting for unsecured financing.
2. How Fast Do You Need Funding?
Lenders process secured and unsecured financing applications at different speeds, given the disparities in complexity.
Secured financing: The collateral requirement makes secured financing a bit more complex. Thus, the process can take longer. Secured financing could work well if you can bear delayed access to funds.
For example, you could use secured financing if you’re planning large-scale business renovations. The assets themselves could serve as collateral, and you don’t necessarily need funding right away.
Unsecured financing: Unsecured financing is faster since lenders only evaluate your financials and credit scores. This can make it more suitable for short-term needs.
For instance, if a supplier offers a limited-time inventory discount, unsecured financing can help you get more discounted inventory and potentially save money in the long run.
3. What Do Your Cash Flows Look Like?
Cash flows are key for ensuring you can repay your financing without trouble. Cash flow strength can determine the best form of financing since each form of financing offers different interest rates.
Secured financing: Secured financing offers lower interest rates, which means the cost of financing is lower and you will likely have smaller monthly payments.
This can work well for growth-focused businesses or companies in industries with tighter cash flows. The smaller monthly payments help minimize cash outflows to keep more in reserve.
Unsecured financing: Unsecured financing comes with higher interest rates given their increased risk to lenders. This can suit them to organizations with stronger cash flows.
For example, established firms with strong cash flows or companies that dominate their market may prefer unsecured financing. The financing may have a bigger impact on their cash flows, but they have access to more loan options and can get funding faster.
4. Is Your Need Short-Term or Long-Term?
Each form of financing can benefit different timelines.
Secured financing: Secured financing can work well for longer-term needs since it offers lower interest rates and more favorable terms.
For example, a smaller business that needs to invest in equipment may favor secured financing to make that equipment easier to finance. The equipment becomes collateral, but the assumption is that equipment helps provide the revenue and cash flow needed to cover payments.
Unsecured financing: Unsecured financing can work for long-term needs under the right financial circumstances. However, the higher rates and faster processing tend to suit it for shorter-term goals, such as purchasing inventory or covering seasonal expenses.
5. What Are Your Credit Scores?
Lenders may look at both personal and business credit scores for either financing type. In both cases, they consider it alongside your business plan, financials, and projections.
However, the weight they place on credit scores varies by financing type.
Secured financing: Lenders consider credit scores for secured financing, but don’t emphasize them as much since the collateral requirements protect against potential downside. Businesses with lower credit scores or little credit history may find getting good rates and terms on secured financing easier.
For example, a new business or younger entrepreneur may prefer secured financing to offset their shorter credit history.
Unsecured financing: Unsecured loans lean more heavily on credit score alongside other factors since lenders don’t have collateral to guard against potential default. Thus, businesses and entrepreneurs with longer histories and higher scores may opt for unsecured financing to protect assets and access more options.
For instance, established businesses with a long positive credit history may prefer unsecured financing. Serial entrepreneurs with solid credit histories could also benefit, even when starting a new venture.
Pick the Best Financing for Your Business Needs
Secured loans may work better for smaller, growth-focused companies with fewer assets. Meanwhile, unsecured loans could be best for established firms with significant assets and stronger cash flows.
Consider what assets you can offer as collateral (if any), how fast you need funding, your cash flows, your financing timeline, and your credit scores.
By evaluating these factors closely and looking over your general financial health, you can find a financing source that helps you grow your company and succeed.
