Unsecured Business Loans

What is an unsecured business loan?

There is no legal definition of what an unsecured business loan is. In the UK it is taken to mean business debt without any form of charge registered against a specific business asset, group of business assets, or over the share capital of the business (a share charge).

Worryingly, some descriptions of this loan type indicate that there is no risk to business assets. In fact, one of the top-ranked google entries for "unsecured business loans" (as of 22nd June 2021) is misleading.

Because they are my competition I won't name and shame them but below is their description:

"An unsecured business loan is a funding option which does not require security, such as valuable business assets. This means a borrower can secure business financing without risking the loss of important assets such as equipment, property, or land".

If you take any form of debt there is a risk of losing business assets, the business itself, and in some cases even your personal property, including your home. Whether business debt is "secured" or "unsecured" the lender still has the option to take legal action to recover the debt.

A comparable example would be not paying your suppliers. Those debts are unsecured but if you think not paying your suppliers will have no repercussions, think again.

Lending criteria for unsecured business loans

Alternative lenders will use two underwriting methodologies when determining if your business is eligible for unsecured loan options. The absence of security means, where possible, they will combine both to maximise their chances of:

  • Preventing default
  • Recovering the loan in the event of default

The Personal guarantee (PG) approach

If you're not familiar with personal guarantees and you're considering unsecured business finance please do take the time to read our guide on personal guarantees (PG).

A PG from a company director or business owner will likely be required to access unsecured finance. This is a major factor that you should consider carefully. The impact of a business loan default on your personal circumstances could be catastrophic.

Any business loan that comes with a PG has some of the characteristics of a personal loan. The characteristic you should be most aware of is that in the event of a default, there is no veil of incorporation between your personal assets and the business. In layman's terms, you could lose everything you have!

The cashflow approach

Without a collateralised asset as the lender's route to recovery, gaining comfort over the borrower's position and cash flow forecast is crucial.

Qualities that lenders will favour include:

  • Little client concentration risk. i.e. revenue is spread amongst a large number of clients.
  • The service or product on offer is contractually or effectively "sticky". "Sticky" is a good word but often misused. A much better measurement is client churn rate or client retention rate.
  • The lender will need comfort that the management team is competent.

When you consider that the primary route to repayment (for the lender) relies entirely on gaining comfort with a cash flow forecast, the above becomes even more important for this type of lending.

You should read my guide on what makes a good business loan application. I've listed a number of items that lenders will like to see and those they will not like to see. If you're considering raising an unsecured loan this is essential reading.

Is my business eligible for an unsecured business loan?

Each lender will have its own criteria but all lenders will follow the PG and/or cashflow approach to credit underwriting for this loan type.

If you can provide the following you'll be in a good starting position:

  • A personal guarantee
  • Forecast financial information showing your ability to service and repay the loan

There will be other measures and factors such as:

  • A minimum annual turnover
  • Checks that monthly repayments are affordable
  • The repayment term (or repayment period) is suitable for the purposes of the loan
  • Background checks on the company, its owner, and directors
  • A good business credit rating with good business credit history
  • A good credit rating and good personal credit history for the Directors and business owners

What are the benefits of unsecured business loans?

  • Less admin and lower professional fees than secured business loans e.g. a property valuation is not required
  • An online application can mean faster approval, particularly vs. secured loans. In some cases, the loan can be funded in a matter of hours
  • A variety of lenders means there's competition in this market
  • If you have no form of security unsecured lending may be your only access to funds
  • Can be an excellent short-term or medium-term funding solution for businesses without assets
  • Does not require tangible assets or other business assets as security (but will likely require a PG)
  • There can be a huge benefit with a cash injection
  • The loan proceeds can be used for a variety of purposes
  • Monitoring and reporting on loan security won't be an issue
  • Suitable for most company formation types, such as limited companies
  • Often cheaper than credit cards

What are the disadvantages of unsecured business loans?

  • Despite the label of "unsecured" company assets will still be at risk of repossession in the event of default
  • A credit check is likely so you and your business may need a good credit score
  • PG likely required so personal assets are at risk
  • May come with early repayment fees
  • It will be more expensive than an asset-backed lending term loan
  • Loan terms may be shorter than secured loans
  • The available loan amounts will typically be lower than secured loans
  • Repayment structure is often rigid
  • Less flexible terms than other types of business funding

Unsecured business loan takeaways

Unsecured lending as a service is important as it fills a gap in the business debt market as a type of funding for businesses that don't have assets. However, unsecured loans are right at the bottom of the commercial loan hierarchy. It's that simple. That's why they cost more than secured loans.

My background is in accountancy, business debt, credit underwriting, and business debt decisioning so I feel qualified enough to be confident with this opinion.

If you want to understand business debt please check out the BorrowingWell classification matrix in my guide on types of business loans. An unsecured business loan falls into borrower classification "C", which with a PG, is little more than a personal loan.

If you'd like to learn more about "secured business loans" please check out my guide.