Lien vs. Collateral: What Does That Have to Do With Small Businesses?

Lien vs. Collateral: What Does That Have to Do With Small Businesses?

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When you are considering applying for a small business loan, you have two choices: a secured or an unsecured loan. Some form of collateral is required to back a secured small business loan, while no collateral is required for an unsecured small business loan. This may appear straightforward, but it can be slightly complicated if you don’t understand the differences thoroughly.

Defining Small Business Collateral

Collateral is an added layer of protection that assures the lender that you have an alternate source for repaying the loan. Assets such as equipment, accounts receivable, buildings and inventory are possible sources of repayment as long as the bank can sell them for cash. It can also consist of personal assets that remain outside the business. Lenders requiring collateral are looking for assets that are easy to value and liquidate. Most online lenders don’t expect real collateral. However, many take a lien on a business’ assets which is also a form of collateral.

Understanding How Liens Work

Attaching a lien to a loan serves as protection for the amount owed. Lenders file liens for a debt owed by a business so that if a company cannot satisfy the financial obligations of the loan, the borrower’s collateral can be sold to try to recover the loaned amount. It is a legal way for a lender to enforce its right to seize a borrower’s business assets if the borrower hasn’t repaid the debt.

Should a company take out multiple loans, the first lender to file a UCC lien has priority over the assets. The second lender to file a UCC lien cannot collect until the first lender removes its lien. Even though lenders can file liens on specific assets, many file blanket liens to allow claims to any business assets needed to recoup the unpaid balance. For that reason, small business owners should:

  • Be aware of all liens 
  • Understand the succession of the liens
  • Define the collateral that is included

In addition to real estate, assets can include money in the bank, patents and even computer codes. It’s a wise plan to incorporate a lien search into a bi-annual or annual debt review.

The Takeaway

Lenders use collateral and liens to reduce potential losses should your business become unable to meet your loan obligations. When comparing your various small business loan options, make sure to ask lenders if they require collateral and if a lien is filed on any business assets. Typically, most lenders prefer not to resort to such drastic actions, but they will if it means protecting their assets.

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