3 Types of Security a Bank May Require for a Business Loan

Your business may need capital for many reasons. It may be to grow your business, acquire more assets, meet everyday business expenses, or even restructure your business. You are not alone. All businesses need capital, whether they are a start-up on the path to success or an established business looking to expand. This article explores three types of security a bank may need to provide you with a business loan. In most circumstances, banks will require all three. 

Types of Capital

Businesses can raise capital through equity capital raising or debt capital raising. Equity capital raising involves obtaining money from investors in exchange for part ownership in your business. Debt capital raising involves obtaining a loan from a lender like a bank. In return, your business promises to repay the loan with interest and give the lender an interest in your assets during the life of the loan as security. The lender can enforce the security should your business default on the loan.

Debt raising is attractive now more than ever. This is because the interest rate in Australia is lower than it has ever been before. In any case, for most small or medium-sized businesses, debt raising through a bank is a more realistic option to raise capital than equity capital raising. The securities a bank may need for a business loan will vary depending on your circumstances and the bank’s assessment of your business’ ability to repay the loan. 

Three Types of Security

1. Mortgage Over Land

Mortgage over land is arguably the most common type of collateral a bank asks for to provide a business loan. It involves a landowner (the mortgagor) giving the bank (the mortgagee) an interest (a mortgage) over their land. This will remain in effect until the landowner has repaid the debt or the debt is otherwise discharged. The mortgage itself is usually registered on the title of the land.

Suppose your business is operating at a leased premises. In that case, it is also common for banks to take a mortgage over the lease itself together with a right over all the personal properties of your business. This will allow the bank to sell the whole business to another entity if the business defaults on its loan. From a bank’s perspective, selling the entire business is more profitable than selling each business asset separately.

2. Security Over Personal Properties of the Business

A bank may require your business to grant it an interest over all your business’ present and future personal property. An agreement called a general security agreement will usually document this. This gives the bank an interest in all your business’ tangible and intangible property. This may include intellectual property, cars, shares and business inventory during the term of your loan. This will give the bank a right to deal with those properties, including selling them, should your business default on its loan.

However, properties like land, any fixtures attached to a land, and certain statutory licences like mining tenements are not considered personal properties and do not constitute personal properties under this security. 

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3. Personal Guarantee from the Directors of the Business

Banks usually also require the directors of a business to provide a personal guarantee to the bank as security for a loan. By giving the guarantee, the directors promise to repay the business’ debt if the business cannot. If you are providing a personal guarantee, you should keep in mind that: 

• it is common for the guarantee document to include a charge provision, under which the bank receives an interest in all the assets of the guarantors as security for the guarantors’ obligations under the guarantee; and
• banks generally have the power to enforce this guarantee before it exhausts all enforcement action against the business, like enforcing other securities like mortgages over land or security interest over personal property. 

From a bank’s perspective, a personal guarantee from the directors is essential, especially when the business operates as a company. A company is a separate legal entity and is therefore responsible for its liabilities. The shareholders and the directors are not personally liable. The personal guarantee ensures the directors are personally liable for the debt. This additionally incentivises directors to manage the business properly and repay the business loan. 

Key Takeaways

In an ideal world, your business will be able to meet all its obligations under any loan agreement and will never have to face a situation where the security you have provided to the bank is at risk. Nevertheless, it is important to consider what security you are providing to the bank for a loan. For a business loan, banks usually ask for a mortgage over land, security over all the business’ personal property and/or a personal guarantee from the business directors.

If you would like more information on the types of security banks may require with a business loan, LegalVision’s banking and finance lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

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