Security is required for some types of finance and will commonly be stated within a financial arrangement and, more importantly, with any formal agreement. This in itself comes with risks to all parties involved with the degree of risk varying the amount of security required.
Larger amounts or substantial assets will require the borrower to provide security, which may consist of business assets, personal assets, guarantees or third-party guarantees or security. Security reduces the risk to the lender; if the business is unable to meet its financial commitments, the lender may take action to seize the security provided. Often legal fees are payable to establish security over specific assets, such as a jointly owned property. Applications to process secured finance will also take longer than those for unsecured funding.
The cost of secured finance tends to be lower than unsecured options and the use of secured finance may be desirable or necessary to achieve the business’s objectives.
Bank overdrafts may be secured or unsecured depending on the circumstances of the applicant and the amount extendible by the bank. In many circumstances an overdraft may be secured if it is part of a larger lending agreement with a bank which may include a loan. As secured overdrafts tend to take considerably longer to be approved, as well as carrying the security encumbrance, they are less flexible in meeting the need of short-term cashflow. But businesses are likely to obtain a lower interest charge and larger facility by using a secured overdraft.
A bank loan often requires security. Secured loans take longer to be approved and require more administrative work than unsecured (for example, additional legal costs to establish security on an asset). Loans may be subject to restrictive covenants and you may need to provide regular updates to the source of the loan for the finance to continue to be made available. Businesses seeking a sizeable amount over a medium-term to long-term period often have little alternative to taking out a loan.
Hire purchase (HP)/leasing tend to be more flexible than loans because they do not require security. Instead, in the case of non-payment the lessor will repossess the asset. This is likely to be more straightforward and less expensive to a business than the enforcement of security on other assets. However, sometimes a leasing agreement may be drafted as an onerous contract and will not allow the lessee to pull out of the agreement without settling the balance owed for the original term of the contract.
Trade loans often require security. Trade loans are a flexible, short-term borrowing facility, linked to specific import or export transactions. They are available regardless of the method they use to trade, whether it’s on an open account, collections or documentary credit basis. Trade loans help fund trade transactions throughout a firm’s trading cycle, improving their cashflow.
Grants usually come with restrictions placed upon it by the grant funder. There will be certain key points in time where your business will have to show compliance with the conditions of the grant and this is normally in the form of a covenant or security.
Business credit cards do not require the provision of security. If used within the grace period to pay the balance spent, they may provide efficient cashflow management for a large volume of low-value transactions.
In return for finance from a business angel or friends and family a share in the business is usually provided. These types of finance do not commonly take any security to protect their interest; however, as they will be shareholders any security provided by the business would be on their behalf by default.
Other types of finance will commonly not require direct security. These include: