Posted on: October 18th, 2019
In the banking world, there are two general loan structures – a secured loan and an unsecured loan. Secured loans have sufficient collateral and are usually 100% asset backed. Unsecured business loans lack collateral and are often viewed as lower quality and higher risk loans by a lender. The collateral orientation of banks is function of regulation and increased reserve requirements for non-collateralized loans.
Banks have to reserve more of their equity to the extent a loan is under collateralized. While some businesses have traditional types of assets on their balance sheet such as accounts receivable, inventory and equipment, many new businesses do not. The new breed of companies in the US are technology and service companies. These types of businesses have no inventory and no equipment on their balance sheets. Their primary assets are their people and their intellectual property, which is not considered a collateralizable asset. Often, asset-light companies are unable to secure necessary growth funding due to their low asset values, which inhibits their growth rate. Typically, these companies expand via acquisitions and introduce their cutting-edge services through the established distribution channel of the acquired entity. It is a sound strategy that both increases the speed to market and de-risks new market penetration issues. To make the acquisition, a loan which is technically an unsecured business loan is required. While the loan may exceed the asset collateral value, it is supported by abundant cash flow value of the business. Cash flow value is the portion of the enterprise value that supports the debt service of unsecured business loan. Cash flow value is usually expressed as a multiple of adjusted EBITDA and is usually 3 to 4 times historical adjusted EBITDA. These types of loans are provided by a variety of different lenders including banks, private debt funds and mezzanine funds.
Different Ways Unsecured Business Loans can help Spur Growth
These unsecured business loans go much deeper into the capital structure than traditional collateralized loans and provide all of the capital a growing business needs to prosper. Here are the top 4 ways that unsecured business loans help to spur growth
- Larger loan size – These loans are much larger than traditional bank loans and give you the capital to both acquire and invest in growth.
- Longer term – Loan terms are generally 5 to 7 years which give you time to grow the asset base and cash flow to ensure repayment.
- Provides gap capital – Gap capital is the extra financing needed for growth and working capital. Unsecured business loans usually provide this level of financing as well.
- Strategic Investment– These loans allow you to make transformative, strategic investment in your business such as an acquisition, diversification or capacity expansion.