Anyone can have a spark of inspiration and create his own business with a little elbow grease. Right? As it turns out, becoming an entrepreneur is a path fraught with obstacles, more formally known as "barriers to entry". A lack of small-business financing is one major barrier to entry that can stop a lot of great business ideas in their tracks, especially for anyone trying to get a startup business loan with no collateral.
Collateral is a tangible and valuable asset that a lender can seize if you're unable to pay back your loan. In other words, the thought of losing your collateral keeps you motivated to pay back your loan, and the loan is considered secured because your personal assets act as security.
Traditional lenders prefer to use big-ticket items like your home, other real estate or car as collateral. If the value is high enough, items like jewelry or art can also be used as collateral for a loan. The problem with secured loans is that they're out of reach for anyone who rents his home, leases his car and doesn't have an expensive art collection hanging out at home. In short, anyone still gaining his foothold in the world is faced with quite the obstacle in the opening chapter of his entrepreneurial journey: getting a startup business loan with no collateral.
How Unsecured Loans Are Enforced
Most unsecured business loans are actually considered personal loans and taken out in the business owner's name, not in the name of the business. This means the consequences of defaulting on your unsecured loan will be borne by you personally. One of the ways lenders can try to collect their debt on a defaulted unsecured loan is through court-ordered wage garnishment, which means a percentage of every paycheck is automatically diverted for debt collection whether you like it or not.
A court-ordered bank levy accomplishes the same thing as wage garnishment but allows lenders to pull funds directly from your bank account instead of from your paycheck. If you happen to own a car or home by the time the aggrieved lender takes you to court, the lender could also have a lien placed on those assets.
Your credit history will take a major hit if you default on any type of loan, which can hinder your ability to get business financing in the future. Even if your financial situation has drastically improved, building up good credit takes time. In short, you should still take an unsecured loan seriously even if the fate of your house isn't directly on the line.
Getting a Startup Business Loan With No Collateral
Despite having no collateral, it's still possible to get a startup business loan. Some options include asking for an equipment loan, signing a personal guarantee, finding a co-signer, seeking out unsecured loans or simply trying a nonloan funding option.
Be aware that, from the lenders' perspective, a loan with no collateral represents a risky option, and they often combat that risk by charging higher interest rates.
Ask for an Equipment Loan
An equipment loan or equipment financing is designed to help small-business owners pay for the machinery or equipment they need in installments. Equipment loans are secured because the equipment itself will be repossessed by the lender if you default on your loan. This type of loan is usually taken in the name of the business, and so having a good business credit score may help you get approved for this type of loan.
Sign a Personal Guarantee
It's ideal to use business assets as collateral for loans taken out under your business's name, but as a startup you may not have any business collateral yet. In that case, you can use your personal assets as collateral by signing a personal guarantee, which states that you'll be held personally liable, and your personal assets will be seized if your business defaults on its loan. Consider structuring your new business as a limited liability corporation to reduce the amount of personal damage you can suffer in these scenarios.
Ask Someone to Be a Co-Signer
Perhaps your new business would be more financially stable with a co-founder or business partner who has a greater chance of getting approved for a secured business loan. If a partnership isn't feasible at this stage, you can still get a bit of help from a very, very good friend or family member who trusts that you'll succeed in your venture.
That person can co-sign a secured loan, essentially promising the bank that they'll make payments if you fail to do so and that their assets can be seized as collateral if neither of you can pay back the loan amount.
Asking someone to co-sign a loan is like asking someone to donate a kidney. Be extremely respectful about the arrangement and try to only ask your closest friends or family members to consider doing it.
Find Unsecured Loans
You can also research banks, credit unions and online lenders to compare the various interest rates and requirements of each financial institution's unsecured loans.
The Small Business Administration has a free borrower portal to help you discover loan options that will work for you based on the amount of money you want to borrow, your credit score, how long you've been in business and how much monthly or annual revenue your business brings in. Most SBA loans, including the 7(a) loan and microloans, do require some sort of equity or collateral. The 504 loan program considers the assets being funded as collateral, but a personal guarantee is required as well.
Your bank may offer you an unsecured loan, often called a personal loan, but a few major financial institutions — notably Bank of America and Chase Bank — simply do not offer personal loans to any of their customers. Instead, you can open a bank account with Wells Fargo, Citibank, PNC, BB&T, Fifth Third Bank and numerous other big-name banks for a traditional loan. Credit unions and alternative lenders like Lending Tree also represent excellent options to pursue so that you find loan terms with which you're comfortable.
Try Other Startup Financing Options
You technically don't need any type of loan in order to successfully fund your small-business startup. If you're really having trouble getting an unsecured business loan or personal loan, check out other financing options, like business credit cards. Getting approved for a credit card usually involves a hard credit check and a basic application process. As long as you find one with a low interest rate and a long repayment schedule, you should have plenty of room to breathe while you use the credit card to finance business purchases and generate enough sales revenue to pay it off.
Crowdfunding is another option that can be wildly successful, especially if you have an innovative product and a knack for online marketing. Crowdfunding platforms will take a percentage of the money pledged to your startup, and you'll also need to pay taxes on the funds you receive. However, after accounting for those expenses, you don't need to repay any contributors.
A merchant cash advance is a lump sum that you repay by allowing the lender to divert a percentage of each credit or debit card transaction. If most of your clients write checks, pay through PayPal or carry cash, a merchant cash advance isn't a viable option. Plus, you may be hit with additional fees while working to pay off the initial amount. A merchant cash advance is popular in the retail and restaurant industries, however, due to the prevalence of card transactions.
Bad Credit Score: Another Roadblock
You have a few options for getting a secured business loan — plus other lending options like an unsecured loan or a line of credit — but the journey isn't over yet. Collateral isn't the only roadblock standing between you and your startup loan, whether unsecured or not. Another barrier that can hold you back is your credit score.
When you set out to create your very first business, lenders will look at your personal credit score to determine your "creditworthiness," or the likelihood that you'll be able to pay back a loan. (Later, lenders will hone in on your business credit score to see whether or not your business handles its cash flow well enough to make reliable monthly payments.) Many lenders look for a score of 700 but will consider credit scores as low as 620.
If your personal credit score isn't very impressive, start fixing it right away by either protesting errors or building credit. It's even more important that you have a high credit score (850 is considered perfect) if you're seeking an unsecured startup business loan.
How to Build Credit
The number-one way to improve bad credit is to start paying every single one of your current bills on time. Write the due dates in your planner a week in advance of the actual due date to help account for processing times or your tendency to wait until the last minute. Use autopay options whenever possible.
If you have a credit card, try not to use more than 30% of the line of credit open to you. Use it for short-term expenses that you can pay off quickly. If you're not sure if all your bills, like your monthly rent payment, actually get applied to your credit score, you can use an app like RentTrack to make sure these on-time payments are considered.
Finally, keep an eye on your credit score because mistakes do happen. You can do a soft check without damaging your credit score. It does take time to build up good credit, so if you're in the early stages of planning your startup idea, it's time to get serious about your credit score. That way, when you're ready to actively seek a business startup loan, you'll run into fewer road blocks.
Proceed With Caution
When searching for a lender willing to give you a small-business loan with no collateral and no business history, you can't give up after one rejection. However, each time you apply for a loan, the financial institution will perform a hard check on your credit, which will automatically lower your credit score. If your credit score is too low to stand up to these hits, proceed with caution. Know your credit score and ask right away if your score will lead to an automatic rejection in order to avoid these penalties.
Final Step: The Business Plan
Besides improving your credit score and checking out your options for finding startup business loans with no collateral, you also need to pay special attention to your business plan. Business lenders want to see your business plan as part of the application process. To them, this document can indicate your business's potential success or failure even more so than your personal credit score.
They'll evaluate not only your business idea but how much thought you've put into it. If it looks like you just typed a stream-of-consciousness paragraph one afternoon about how much you'd love to open an '80s fashion store, you're guaranteed to be declined. However, if your business plan shows that you've performed market research and thought about how you'll overcome potential challenges, then you're more likely to be taken seriously when you ask for a business loan with no collateral.
- NerdWallet: Wage Garnishment: How It Works and What You Can Do
- Experian: What Is a Good Credit Score?
- NerdWallet: Is a Merchant Cash Advance Right For Your Business?
- Fit Small Business: Equipment Loans – How They Work & Where to Find One
- Merchant Maverick: What Is Collateral & Do I Need It For a Business Loan?
- Credit Karma: Secured and Unsecured Personal Loans: What’s the Difference?
- U.S. Small Business Administration: Office of Financial Assistance | Resources
- Student Loan Hero: Chase Personal Loans Don't Exist: 9 Banks to Try Instead
- NerdWallet: How to Build Credit
- Experian. "What Can a Personal Loan Be Used For?" Accessed Oct. 22, 2020.
- MyCreditUnion.gov. "Personal Loans: Secured vs. Unsecured." Accessed Oct. 22, 2020.
- Consumer Financial Protection Bureau. "What Is a Personal Line of Credit?" Accessed Oct. 22, 2020.
- Consumer Financial Protection Bureau. "How do I pay back my Personal Line of Credit?" Accessed Oct. 22, 2020.
- Metro Credit Union. "Secured vs. Unsecured Loans." Accessed Oct. 22, 2020.
- Marcus by Goldman Sachs. "Personal Loan Calculator." Accessed Oct. 22, 2020.
Cathy Habas specializes in marketing, customer experiences, and behind-the-scenes management. Cathy has contributed to sites like Business and Finance, Business 2 Community, and Inside Small Business. She served as the managing editor for a small content marketing agency before continuing with her writing career.