Unsecured business loans is a general term that can mean a variety of things. It takes market understanding and structuring expertise to evaluate a given unsecured business loan. Unsecured business loans are provided by non-bank providers of capital who have a comfort level with higher risk and rely upon the ongoing cash flow of a business for eventual repayment.
An unsecured loan is one where the loan is not backed by any sort of collateral. Instead, it is based on the creditworthiness of the particular business the loan. There are various types of legal mechanisms to secure collateral such as perfected liens, assignments, and escrow. Unsecured business loans provide more flexibility to a borrower and usually have a higher interest rate. Unsecured lenders charge higher rates because their loans generally have a higher level of risk. Yet, despite their higher cost Vis a Vis a secured business loan, they provide a higher level of value for money and can be more impactful to a company that needs money to grow.
There are various names for unsecured business loans in the corporate finance world. They include over advance, air ball, term loan, mezzanine loan, second lien loan and term loan B. Unsecured business loans are very beneficial for company as they allow companies to tap more money that can be brought in through a secured business loan. Most growing US Companies have low asset bases, because most growth companies are technology and service companies.
In the old days, most companies had large amounts of equipment and inventory on their books. Banks require hard collateral to secure any loans they make in today’s market. Providers of unsecured business loans such as mezzanine lenders, are gaining share over banks because they can offer the benefit of unsecured business loans.
The mezzanine approach to unsecured business loans is to structure the loan as a fixed multiple of the borrower’s EBITDA. This approach completely ignores the borrower’s level of balance sheet assets. For example, if the borrower has assets of $1 million and EBITDA of $1 million, the mezzanine lender can lend 3 times or $3 million to the borrower, as a rule of thumb.
If a bank looked at the same borrower, they would probably only lend 80% against the value of the assets. There are many benefits to bringing in an unsecured business loan. First, you can bring in more capital. Having more capital is key to being able to maintain your growth rate and having the ability to make strategic investments.
Second, unsecured loans generally have longer terms for repayment. This lets the borrower keep the cash flow in the business to fund long term improvements that will result in a much higher exit value for the business. Third, unsecured business loans are complementary to secured business loans and usually are in second position in the capital structure. Having both a secured lender for day to day working capital needs combined with an unsecured business lender for long term improvement, is a great way to go.