Secured vs unsecured loans to buy a business

An unsecured business loan means no mortgage over real property. It does not mean the lender takes nothing. Almost every unsecured lender requires personal guarantees from the directors, and most register a general security agreement over the assets of the business. If the loan defaults, the lender can pursue the guarantors personally, including through court action that can eventually reach their property. Approval is based on bank statements, trading history and credit scores, which is why these loans suit an existing operator buying a second business better than a first-time buyer. A new owner with no trading history of their own has little for an unsecured lender to assess.

Lenders rank security by how reliably it can be sold. Residential property is at the top, and lending commonly reaches 80% of value. Commercial property follows at 65% to 70%. Plant, vehicles and equipment can be funded through asset finance secured against the items themselves. The business is last. A loan secured only by a general security agreement over the business, often called a goodwill loan, is commonly limited to about 50% of the purchase price. Higher ratios apply in sectors with recurring income, such as healthcare and accounting practices, pharmacies, childcare centres, rent rolls and accredited franchises. How property is used as security is explained in using home equity to buy a business.

Loan size is the first difference. Property backed loans are limited mainly by the available equity and the ability to service the debt. Goodwill loans are limited to a share of the purchase price. Unsecured loans are limited by policy, with most lenders capping them at around $250,000 to $500,000 and many first-time borrowers approved for much less. Term is the second difference. Residential security supports terms of up to 30 years and commercial property 15 to 25 years. Goodwill loans are commonly repaid over three to ten years. Unsecured loans commonly run from a few months to five years, sometimes with daily or weekly repayments.

Cost and speed move in opposite directions. Property backed lending carries the lowest pricing because the lender's risk is lowest, but it needs a valuation, a mortgage and legal documents, and a bank commonly takes four to eight weeks to settle. Unsecured lenders can approve and fund within days, at a much higher cost. Short terms also mean large repayments. The same amount repaid over three years instead of fifteen puts far more strain on the cash flow of a business that has just changed hands.

A secured loan fits most purchases: where the price is above a few hundred thousand dollars, where the buyer needs repayments the business can comfortably carry, or where the industry is one that lenders will not fund on goodwill, such as cafes, restaurants and general retail. An unsecured loan fits a small purchase, a top-up to cover stock or working capital, or a gap between the main loan and the price. It can also suit an experienced operator who needs to settle quickly and plans to refinance into a secured facility later. That plan only works if the refinance is realistic, so it should be tested before relying on it.

Most business purchases are funded from more than one source. A common structure has property equity funding the buyer's contribution, a goodwill or business loan funding part of the price, asset finance covering vehicles and equipment, and an overdraft or small unsecured facility for stock and working capital. Vendor finance, commonly 10% to 30% of the price, sometimes fills the last gap. Every facility adds a repayment, and the lead lender will include all of them when testing serviceability against maintainable earnings, commonly looking for cover of 1.25 to 1.5 times. The lending ranges for each layer are set out on the loans to buy a business page.