What is an unsecured business loan?
An unsecured business loan is a type of financing that doesn't require you to pledge physical collateral — like business equipment, inventory or real estate — to secure funding. But even though physical collateral is not required, that doesn’t mean you’ll necessarily be off the hook if you can’t repay an unsecured loan: Most are backed by either a personal guarantee or Uniform Commercial Code lien.
A personal guarantee holds you personally responsible for the debt if your business cannot pay, and the lender can seize your personal assets to recover their losses in the case of default. A UCC lien gives a lender the right to seize your business assets if you’re unable to repay your loan. Lenders typically file UCC liens with your secretary of state’s office after you sign your loan agreement.
Your lender may file a lien on specific assets, or they might file a blanket lien, which allows them to seize any business assets necessary to recover their losses.
» MORE: Differences between secured and unsecured business loans
How do unsecured business loans work?
Unsecured business loans typically work like other types of debt financing — you apply for a loan, receive funds and pay back what you’ve borrowed over time with interest.
Unsecured business loans typically fund faster than secured loans because the lender doesn’t have to check the value of your collateral. The lack of collateral, however, also makes them riskier for lenders. That’s why unsecured loans usually come with higher interest rates and require a personal guarantee.
Types of unsecured business loans
There are many different types of unsecured business financing, including:
Term loans
Term loans are likely what you imagine when you think of a business loan. These loans are lump sums of capital that you borrow from a lender and repay over a set period of time. Term loans can be a good option if you need to make a specific investment or purchase for your business.
Business lines of credit
Credit lines are a flexible form of financing that allow you to borrow up to a certain limit and only pay interest on the money you borrow. You then repay the funds and continue to draw on the line. Unsecured business lines of credit can be used for working capital, as well as other short-term expenses. These products are also used as emergency funds.
Invoice factoring
Invoice factoring lets you sell your unpaid invoices for cash advances. The factoring company then takes control of your invoices and is responsible for collecting payments from your customers. Although factoring companies may want to see established invoicing practices and a certain amount of time in business, you may not have to provide a personal guarantee — since you’re selling an asset to them directly.
Merchant cash advance
With an MCA, a lender advances you cash based on your sales, and you repay them with a portion of your future sales. This type of financing is usually easier to qualify for than other business loans. Merchant cash advances are risky and expensive, however, and should be treated as an option of last resort.
SBA 7(a) loans
SBA 7(a) loans up to $50,000 may not require collateral. This includes programs such as the SBA 7(a) Small, Express and Export Express programs. However SBA loans do require an unlimited personal guarantee from anyone who owns at least 20% of a business.
Pros and cons of unsecured business loans
Pros
Speed. Applications can usually be processed quickly.
Collateral not required. You can get financing even if your business doesn’t have many physical assets.
Can be easy to qualify. Some lenders offer unsecured business loans to startups and/or businesses with bad credit.
Cons
Can be expensive. These loans tend to have higher APRs than those secured by collateral.
Assets can still be at risk. You’ll probably have to provide a personal guarantee, which puts your personal assets on the line, or a business lien, which allows a lender to seize the assets your business does have.
Less desirable terms. Because lenders consider unsecured debt more risky, you’ll often receive higher interest rates, lower loan amounts and shorter repayment terms than you might receive with secured business loans.
Can be difficult to access the best options. You’ll likely need strong financials and credit to get the most competitive unsecured loans, typically offered by banks. Although some lenders will be more flexible with their criteria, you’ll also want to be wary of predatory lenders that may lack transparency or make too-good-to-be-true claims.
🤓 Nerdy Tip
Predatory lenders are lenders that impose unfair or deceitful loan terms on a borrower, and target high-risk borrowers in particular. To avoid these lenders and scams, always look for transparent terms and rates, compare fees to reputable lenders and check to see if the lender reports to one of the three major credit bureaus.
How to get an unsecured business loan
You may be able to get an unsecured business loan from both traditional financial institutions, like banks and credit unions, and online lenders.
Generally bank loans will offer the most competitive interest rates. However, to qualify for an unsecured loan from a bank, you’ll likely need multiple years in business, strong personal credit and excellent annual revenue.
In comparison, online lenders may have more flexible qualifications and can be faster to fund than traditional lenders. But like banks and credit unions, online lenders may also require a personal guarantee for a business loan without collateral.
» MORE: How to qualify for a small-business loan
Alternatives to unsecured business loans
If you don’t think an unsecured business loan is a good option for your business, you might consider these alternatives:
Business credit cards
If your time in business is too short to qualify for an online business loan, business credit cards for startups are typically available to companies of all ages. Business credit cards offer flexible, unsecured financing that you can use for everyday spending as well as larger purchases, depending on your credit limit. You’ll likely still need to provide a personal guarantee, though.
Small-business grants
Small-business grants can be a good option if you want to avoid taking on debt — or can’t yet qualify for affordable financing. It can be time-consuming to find and apply for the right grant for your business — but if you can secure one, you have access to free funds you don’t need to repay.
Crowdfunding
Crowdfunding can also be worth considering if your business doesn’t quite meet traditional loan requirements. You can create a business profile on a crowdfunding platform, like Kickstarter, and publish a funding goal to raise money from the public. Typically, you’ll offer some type of reward or equity in exchange for funds. Crowdfunding can be a particularly good choice for product-based businesses that have an internet following.
Find the right business loan
The best business loan is generally the one with the lowest rates and most ideal terms. But other factors — like time to fund and your business’s qualifications — can help determine which option you should choose. NerdWallet recommends comparing small-business loans to find the right fit for your business.
