What does collateral mean in business?

If you own a business, you might need funds to run and manage its guarantee effectively. Such funds can be raised by either opting for a secured or unsecured loan. You may also need to offer collateral to get the loan application approved. But, what exactly is the collateral?

What is business collateral?

Collateral is an asset or property that is offered to the lender against the loans.

The collateral acts as a form of protection for the lender and loans that are backed by collateral are known as secured business loans. Collateral may take the form of real estate, inventory, or other kinds of assets, depending on the purpose of the loan. The collateral-based funding fetches a lower rate of interest.

Example

Let us suppose that Mr. Ram owns a business and needs a fund for expanding the same. He also owns a property that is registered in his name. In such a case, Mr. Ram can use this property as security against the loan and obtain a secured loan against the property.

Kinds of collateral

The following are the kinds of collateral used against the loans,

1. Real Estate

The borrowers maximum use real estate assets as collateral viz building, apartment, premises, flat or a bungalow. The land is also used commonly as collateral.

2. Equipment or Machinery

The borrowers can, however, obtain loans against the equipment as well as machinery by keeping them as collateral against loans.

3. Inventory financing

The manufacturing companies can have a crore of rupees stock which is kept idle till the time it gets converted to cash. Also, the turnaround time for converting to cash is high. In such a case, the inventories can be kept as collateral for acquiring finances.

4. Invoices (unpaid)

The unpaid invoices. i.e., the outstanding invoices are commonly used as collateral. In the cases of Bill discounting and Factoring, such invoices are discounted and the funds are availed against them.

How does collateral funding work?

For availing of a collateral-based or secured loan, one must possess a tangible and lawful asset as collateral. Unregistered or unlawful assets are unlikely to get funding. Next is the valuation of property, whether the property serves the purpose of the required amount. Since the volume of funds depends upon the value of the mortgaged asset and one cannot get funds beyond that. The loan is given based on the fair market value of the property.

The benefit of collateral-based loans

1. Loans are given against the assets which will be used as collateral. The assets include fixed and tangible assets like land, building, machinery, etc.
2. Lower interest rates as compared to collateral-free loans.
3. More flexible tenures and repayment options than regular loans.
4. Faster approval process.

Collateral vs. Security

Collateral and security are two different concepts. Below is the explanation of both,

Collateral is any fixed or tangible asset given by the borrower to the lender in order to secure a loan. These include land, building, property, machinery, etc.

The ownership of the mortgaged asset stays with the lender throughout the time the borrower is paying the loan.

Whereas, security refers specifically to financial assets (such as stock shares) that are used as collateral against loans. These include bonds, futures, swaps, options, and stocks.

Why Terkar Capital?

Terkar Capital is one such institution that provides a wide range of products to clients after studying all the aspects of financials, CIBIL score, business plan, industry, sales, etc. We arrange conventional and non-conventional debt and equity funding solutions at a reasonable cost of borrowing. Our timely and confidentiality in the services makes us different from others. So whenever it is raising funds for corporate, Terkar Capital is ready to serve you at best!