I had a somewhat distorted understanding of collateral and its significance when making a loan because I was new to the commercial lending industry. As time has passed, I have come to understand not only how crucial it is to have collateral when making a loan, but also how crucial it is to have it. First of all, what exactly is collateral and why is it necessary to obtain a commercial loan?
To avoid sounding too straightforward, collateral includes anything and everything that a lending source can take a security interest in, such as inventory, equipment, vehicles, notes receivable, land and buildings, and accounts receivable. You may be wondering why lending institutions seek security interests in these assets.
I’m happy you asked. in order to reduce their potential loss in the event that they fail to repay the loan. Nothing in life is certain, just like in our personal lives, and no one has been able to consistently and accurately predict the future. Banks use assets as collateral to not only guarantee repayment but also to cushion the blow in the event of an unexpected event.
The use, age, and resale value of the assets you may be required to put up as collateral determine their marketable value. For startups and businesses in their early stages, having collateral is essential. The acquisition of assets with some ownership interest or at least a controlling interest is the second objective for a startup or early stage business, along with becoming cash flow positive as quickly as possible.
Obtaining a commercial loan will be significantly easier if these objectives are met early. It not only reduces business, operational, and collateral risk in the eyes of the lender, but it also enables you to negotiate better loan terms.
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