Secured vs. unsecured startup business loan

If you’re starting a new business, you’ll need money to pay for everything from equipment and inventory to your employees’ salaries. Startup business loans are one way to get funding for a new company, and while the 2023 Small Business Credit Survey found that businesses under five years old were more likely to receive funds from personal sources — like friends and family — startup business loans are a viable option.

But there are several types, including secured and unsecured options. Secured and unsecured startup business loans each have pros and cons, so you’ll need to review your business’s needs carefully before determining which is best.

What are the key differences between secured and unsecured business loans?

Secured loans for startup businesses require collateral, such as business equipment or real estate. If you fail to repay the loan, the lender can seize the collateral. In exchange for the added risk of holding collateral, secured loans come with more flexible terms and lower interest rates.

On the other hand, unsecured loans for startup businesses do not require collateral. This means you won’t risk losing important assets if you fail to repay the loan. But unsecured business loans carry more risk for the lender since there is no collateral to back the loan. The lender may charge higher interest rates or require a personal guarantee to offset that risk.

Secured loans for startups

Secured loans are popular for startups because they can be easier to qualify for than unsecured loans. Lenders are often hesitant to lend to new companies with no track record of repaying loans. Collateral reduces their risk, making them more willing to lend.

Secured loan pros

• Easier to qualify for: Secured loans are typically easier to get than unsecured loans. If you can demonstrate basic personal and business financial health, along with showing you have valuable-enough collateral to cover the loan, you’re off to a good start.
• Lower interest rates: Offering collateral reduces lenders’ risk, letting them offer lower rates.
• Some lenders let you use the loan to buy the collateral: For example, you can get a loan to buy equipment and use the equipment itself as collateral, which can help you get a loan even if you don’t have assets to start with.

Secured loan cons

• You need collateral: Not every business has assets to use as collateral, so secured loans aren’t an option for everyone. If you have limited assets, that could also impact your borrowing limits.
• Risk: You put your collateral at risk of seizure when you get a secured loan.
• Longer approval times: Secured loans are more complex to underwrite, as the lender must verify your collateral’s value, which can extend the approval and funding timeline.

Unsecured loans for startups

Getting certain types of unsecured business loans as a startup can be harder than getting a secured loan. Unsecured term loans and lines of credit are often more difficult to get until you’ve been running the business for months or years and can show a track record of profitability. Even so, there are some types of unsecured loans that startups could qualify for, like merchant cash advances.

Unsecured loan pros

• No assets needed: Because you don’t have to offer collateral, you can get an unsecured loan even if your company has no assets.
• Less risky: You’re not putting your assets at as much risk with an unsecured loan. However, if you’ve signed a personal guarantee, the lender could pursue your personal assets if you default.
• May be discharged in bankruptcy: It’s typically easier to discharge unsecured loans in bankruptcy than to discharge secured loans. With careful debt management and smart business practices, hopefully, this pro will never become relevant to you.

Unsecured loan cons

• Harder to qualify: Lenders may have stricter requirements if you want an unsecured loan. You might have to demonstrate higher revenue or wait until you’ve accumulated six or more months in business.
• Limited borrowing ability: With secured loans, you can borrow large amounts, assuming you have sufficient collateral. Unsecured loans typically have lower borrowing limits.
• Higher costs: To compensate for the higher risk, most lenders charge higher fees and rates on unsecured loans.

Which is better for my startup?

In general, most startups will have better luck with secured loans. As a new company, getting an unsecured loan can be difficult. Even if you find a willing lender, you can expect to pay high interest rates.

If your company has sufficient assets to serve as collateral, it’s a good idea to start by looking for secured loans.

If your company has limited assets that won’t serve as effective collateral, you’re left with unsecured loans as an option. To give yourself the best chance of qualifying, you’ll likely need to wait a few months and build a history of profitability to show lenders that you’ll be able to pay back the debt.

Your personal credit will also likely come into play if the lender asks for a personal guarantee, so make sure you have good personal credit before applying.

What are alternatives to secured and unsecured startup business loans?

While secured and unsecured startup business loans are two options for financing your business, you can also look into alternative methods of financing, such as:

• Crowdfunding: Involves raising money from a large number of people in small amounts to fund a project or venture. Crowdfunding is usually not an option to finance a business if you’re seeking a large amount of money, but you can use it in the early stages of launching your business. One of the most popular types of crowdfunding is reward-based, where donors receive a product or service related to your business in exchange for their contribution.
• Peer-to-peer lending: This is a more informal type of lending that usually doesn’t require collateral. As with crowdfunding, peer-to-peer lending may not be a viable option if you’re looking for a large amount of money. However, peer-to-peer lending typically has less stringent requirements, and investors may be more open to lending to a startup than a traditional lender would be.
• Business grants: Awards given to businesses by a government agency, corporation or nonprofit foundation. You do not need to repay the money, allowing you a way to fund your business without debt financing. Grants often target specific types of small businesses, such as those run by minorities, women or veterans.
• Personal loans for business: If you run out of options, consider a personal business loan. Keep in mind that you will be responsible for making payments and that repayment terms are dependent on your creditworthiness. Even individuals with bad credit may be able to find options, as alternative and online lenders may offer bad credit loans.
• Business credit cards: This is another option for financing, especially for businesses not looking to borrow a large amount. Interest rates tend to be higher than business lines of credit or loans, but you aren’t charged interest if you pay your balance off every month. Additionally, many business credit cards come with perks, such as cash back, points or air miles. They also can have introductory APRs.

The bottom line

Borrowing money as a startup can be tricky, and secured loans are usually your best bet. If you don’t have collateral, you may still be able to find unsecured loans, but you’ll want to review your options carefully. Regardless of which loan you choose, follow the right steps to apply for a loan and shop around to get the best deal.

Frequently asked questions

• What are the key differences between secured business loans and unsecured business loans?

  Secured loans require collateral, such as business equipment or real estate, and come with more flexible terms and lower interest rates. Unsecured loans do not require collateral but often require a personal guarantee. The best unsecured business loans are available only to borrowers with higher credit scores. They tend to come with stricter requirements and higher interest rates.

• What information is required during the application process for secured and unsecured business loans?

  The application process for both secured and unsecured loans requires similar information, including a company’s financial documents, personal and business credit scores and personal details. Depending on the type of loan, you may also need to present a business plan. In the case of secured loans, you’ll also be asked to provide information about the collateral that will be used to secure the loan.

• What are the criteria to consider when deciding between a secured or an unsecured business loan?

  When deciding between a secured or an unsecured business loan, consider the collateral, risk, credit impact, interest rates and borrowing limits.