Unsecured business loans and business overdraft facilities are often thought of as the credit options of last resort only to be used in times of hardship if not outright desperation. Whilst both can help a business to lubricate cash flow blockages, the high interest rates, harsh creditor terms and impact on credit ratings can do more long term harm than short term help. Whilst overdrafts are more palatable, they are still far from ideal. In this post we shall examine whether they should be avoided altogether or if they in fact do have a time and a place.
So Should A Business Ever Use Unsecured Credit?
Before we begin it is worth taking a moment to reflect on what the word “should” really means here. The word itself suggests a state of being that is theoretically possible but has for some reason not quite being attained. Therefore telling individuals or telling a business how things “should” be can either provide welcome direction and guidance or else it can simply prove patronising. The fact of the matter is that no business ever really wants to have to rely on unsecured lending, but sometimes there is no other viable option. Now that we have established that, let’s take a closer look at when a business may need to resort to unsecured credit.
Unsecured Business Lending
In an ideal world nobody wants to be in debt of any kind and yet in reality, debt is very common – in fact the average American is $90k in debt. Student loans and mortgages are both examples of “acceptable” kinds of debt that have become something of a staple of modern life.
Now when it comes to founding and establishing a business, some form of borrowing is needed in almost all cases whether it’s a start up loan, or financing for further expansion. Furthermore, unless the founder/owner has an equitable asset against which to obtain the business financing, then the lending will be unsecured in most cases.
However, even though unsecured business lending is fairly commonplace, it is still far from desirable. Unsecured lending is considered by lenders to be high risk. If the borrower defaults and fails to repay the money, then the lender has no collateral and no assets to seize in order to repay the money. Whilst the lender is legally entitled to effectively hound the borrower indefinitely, the reality is that lenders are usually left in a loss position.
For this reason, lenders charge much higher interest rates for unsecured lending than they do for secured lending in order to offset the risk. As well as applying higher interest rates, unsecured lenders are usually less tolerant of defaults and tend to be faster in instigating recovery action than they are with secured lending.
Basically, whilst unsecured lending is an inevitable need for many start-ups and new businesses, the best course of action is to borrow the lowest amount possible and then to try to avoid ever needing to rely on unsecured lending again.
Business Overdraft Facilities
An overdraft is a semi-formal kind of credit facility whereby bank account holders are allowed to run a negative balance on their account up to an agreed and specified limit. Business overdrafts can serve as a very useful cushion for occasions when the business is having cash flow problems, gets an unexpected bill or wishes to make a larger than usual, one-time purchase.
One drawback with overdrafts is that the limit tends to be on the lower side although extensions can be negotiated. Other issues are that banks tend to apply both monthly interest and also charge a monthly overdraft usage fee. Still, banks are typically happy to let customers effectively ‘live’ in their overdraft and rarely chase for repayment.
As such, when an existing business needs a cash injection, to pay an expected large bill or acquire new business assets, then overdrafts are more palatable – using the overdraft can often prove a lot smarter and more effective than seeking unsecured lending. Of course, as overdraft limits tend to be limited to relatively low amounts, the overdraft may now always cover the entire cash injection amount which a business needs and in these cases, unsecured borrowing may be required.
As we have seen, the fact is that most businesses do need to borrow money at some point – after all, it takes money to make money and accumulation can only ever follow speculation.
With that in mind, business owners do not need to be overly afraid or concerned about borrowing, even when that borrowing is unsecured business loans. As long as a business borrows carefully and sensibly and uses its business overdraft facility appropriately, it has every chance of succeeding.