There are two main types of loans; secured loans and unsecured loans. The term “taking security” means making a loan but requiring the borrower to offer up an asset as security. If the borrower doesn’t repay the loan then the lender can enforce the security; essentially claim the asset and have it sold to repay the debt.
The classic secured loan is the traditional home loan. The bank lends the borrower the capital to purchase the house, but keeps the title deeds to the house until the loan is repaid in full. If, at any time during the term of the loan, the borrower fails to make repayments, the bank can sell the house in order to reclaim the debt.
In a business context, businesses often borrow money and secure the loan against the assets of the business, such as plant and equipment. Taking out a secured loan generally means that the borrower will have to pay a lower interest rate than they would if they’d taken out an unsecured loan. If the lender has more certainly that it will be repaid, the loan is less risky, and the bank can therefore offer a lower interest rate.
Many small businesses don’t have significant assets and therefore can’t offer traditional security. One type of loan which small businesses without significant assets can consider is an invoice factoring agreement. The invoice factoring funder will provide upfront cash (usually up to 80% of the value of your outstanding invoices) and be repaid when your customers pay their invoices. This type of borrowing can solve a sort term cash flow issue for businesses which have a negative cash flow cycle.
If a business has a reasonable track record of success it may be able to borrow an unsecured revolving credit facility from a bank. This allows businesses to manage their cash flow more efficiently. A basic overdraft is another example of an unsecured loan that most banks are prepared to make to small businesses.
Finally, individuals make unsecured loans to friends and family on an everyday basis. It’s fair to say that this type of lending often causes more problems than some of the commercial loans discussed above!
There are many types of loans available to both businesses and individuals. In general, the more security you give, the safer the loan will be, and the less interest you will pay. It’s important that you work with a lawyer to review any non-standard loan agreement. If you’re lending money as either a business or an individual it’s crucial that you work with a lawyer to draft an enforceable loan agreement and security documents.