Here's a quick guide to some of the frequently asked questions we hear from small business owners.
What is an unsecured business loan?
An unsecured business loan is a loan where the lender does not require collateral. This allows you to seek finance without risking your personal assets, although the lender might require some kind of guarantee in order to de-risk their decision to lend to you without collateral.
By way of contrast, a secured loan is a loan which is secured with collateral. A common form of security is personal property. For example, a business owner might be required to agree that the lender can acquire their home if the business defaults on the loan. This makes the loan less risky for the lender because they have an avenue for compensation if they are unable to recoup the money through the agreed repayments. However, this makes the loan riskier for the business owner because their family home is on the line.
Hang on, what's 'collateral'?
Collateral is the lender's way of describing any assets that you own that might be useful for your current application. The lender doesn't think about your personal or business assets in terms of the intangible value they hold. Instead, the lender thinks about these assets in terms of how much they would be worth if you were to sell them today. The lender calls these assets 'collateral', and measures their value against the requested loan amount, to work out how much they are likely to get back if you're unable to repay your loan.
It's important to seek advice from your accountant, lawyer or trusted business adviser if you are considering any type of business finance. Make sure you understand the contract that you are signing and ask plenty of questions about the meaning and impact of each clause in the contract. The greater your understanding of your obligations, the less likely you are to find yourself in hot water later on.
What can an unsecured loan be used for?
An unsecured business loan can be used to purchase property, renovate your premises, buy inventory, increase staff headcount, purchase equipment, increase working capital, ramp up marketing efforts or pay an outstanding tax debt. An unsecured loan can be used for a variety of purposes across the business, from operations through to resourcing.
Most lenders will want to see your Business Plan, and they'll want you to clearly articulate how you plan to use the funds you're requesting. This is a standard request from lenders, so be prepared to justify how you're planning to spend the money.
What happens if I have bad credit?
Credit scores work on a scale with certain ranges to indicate the strength of an applicant's score. Most credit bureaus will use a scale from 0 - 1200. If your score is between 625 and 725, it is likely to be considered 'good'. If it's between 725 and 825, it is likely to be 'very good', and if your score is over 825 it's likely to be considered 'excellent'.
Every single day people are making transactional decisions that impact their credit score. There is no single definition of what constitutes 'bad credit', rather lenders are looking for an indication of how you manage credit. Credit scores are a way for the lender to quickly get a sense of how carefully you spend your money and how prudently you manage your available credit.
Credit score providers collect data from banks, credit unions, store credit issuers (such as store cards), payday lenders, telecommunication providers, utility providers, and public records. There are also a number of things factored into the final calculation, including credit enquiries, length of credit history, credit limits and any repayment defaults.
There can be some variance in your score depending on which credit bureau the lender uses, but regardless of the bureau, demonstrating strong financial management and angling for incremental increases in your score will put you in good stead for future credit applications.
If you're thinking about applying for a loan in the short to medium term, avoid making applications for finance. This can negatively affect your score as it is interpreted as 'shopping around'.
Personal credit vs business credit score
For many small business owners, their personal and business scores are intertwined. This is because many small business owners use their own funds to supplement the business when they experience a mismatch in cash flow timing. In many cases, the owner's ability to pay off their personal debts is intrinsically linked to the success of the business, and for that reason, a lender may want to see both your personal and business credit score when assessing your application.
How can I improve my score?
Credit scores are not absolute, and demonstrating strong financial management over a period of time will improve your chances of being approved for an unsecured business loan. If you have a large amount of debt and you're finding it difficult to pay it off, it might not be the best time to apply for a business loan. This is because there's a chance that you're already at capacity when it comes to your ability to repay debt.
Lenders look at this as 'serviceability'; would you be able to service a loan by keeping up with repayments? If the answer is no, it's a good idea to have a chat to your lawyer, accountant or trusted business advisor and revise your business roadmap for the next few months.
What are alternative lenders?
There's been a lot of hype around alternative lenders and what they can offer small businesses. Traditionally, a small business owner might've had a positive relationship with their local bank manager, and would speak to this person about their personal and business finances. Business owners were beholden to the major banks if they wanted a loan, and the process of submitting an application and all the required documentation could take weeks or even months.
Alternative lenders offer greater flexibility to small businesses. As they are generally smaller institutions than the major banks, they are sometimes able to offer a shorter turnaround time for business loans. However, it is important to keep in mind that any loan contract comes with obligations and responsibilities that can become burdensome and stressful for the business owner if they are mismanaged, regardless of the lender.
If you're exploring your options, be sure to look at the full spectrum of financial products to ensure you find the right fit for your business. If you're finding the search difficult, Valiant offers a smart loan matching tool that can make it easier to compare options across the market. Check it out here.
Why is it important to compare lenders?
An unsecured loan can have a real impact on your business, so it's vital to ensure that the loan amount, loan term, fine print, terms and conditions are all the right fit for your business. Many business owners start the process of looking for funding with the view that the lowest interest is what they're looking for. However, small businesses are subject to a lot of scrutiny when applying for a loan, and as a result, speed to funding becomes an important factor. For example, if you start looking for finance in order to fund a growth opportunity but the contract is time-bound, you might find that speed to funding is more important than the lowest rate. Comparing lenders and doing your research gives you the opportunity to find a balance between the two, rather than sacrificing one for the other.
How do I apply?
If you're ready to apply, give yourself a head-start by organising your documentation. There are a few key pieces of documentation that most lenders will ask for. If you've got these ready to go, it gives you more time to get organised if the lender asks for something that isn't readily available.
The key areas are:
- Identification documents
- Business financial statements
- Business tax returns & statements, as well as details of any outstanding tax debts
- Business bank account statements
If you need help taking the next step, our in-house lending specialists will be able to help you learn more about the process and decide what your next steps will be. If you're interested in a no-obligation chat with the experts, give us a call on 1300 780 568.
Nicki is the Senior Working Capital Product Specialist at Valiant. Nicki has impressed hundreds of Australian SMEs, working closely with business owners to achieve successful outcomes for their business.