Secured vs Unsecured Funding: What Type of Loan is Best for your Business?

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Managing your business is no easy feat.

Finding smart ways to invest and grow your business in South Africa is essential for making a success of your venture.

Competition can be fierce, and business owners need to stay ahead of the game if they want to survive and thrive in a cutthroat environment.

Acquiring a business loan in South Africa can be a real game-changer for business owners looking to expand their enterprise. That’s not to say you won't face your fair share of objections and cautionary tales from naysayers.

With that being said, taking out a loan in South Africa does have its risks for a business which is why it is important to make sure you are aware of the different types of loans available as well as interest rates, repayment terms and the claims a lender might have over the business or personal assets if something should go wrong further down the line. Understanding the pitfalls is the difference between a good and a bad loan decision.

To help you better understand what it takes to access responsible financing, here is a concise breakdown of the differences between secured and unsecured business loans and how to establish the best course of action for you.

Reducing Financial Risk

Before we dive into the details and establish the pros and cons of secured and unsecured loans, it’s important to discuss financial risk.

When lenders provide loans, they want some assurance that they’ll get their money back.

Despite the best of intentions, some businesses will unfortunately fail and default on their loans. To protect themselves against this, loan providers use collateral to secure loans.

Even unsecured loans usually require a personal guarantee of some sort. Fundamentally, lenders need some sort of legal protection which entitles them to pursue the business or business owner in the event of default.

Secured Funding

Once you start shopping around for financing options in South Africa, secure business loans will probably be the most common option available.

These loans are often the most straightforward option as they are backed up by assets such as property or equipment. If a borrower defaults on the loan, the lender will sell those assets to recoup their losses.

The Pros of Secured Funding

The benefits of a secured loan for the business owner are that: 

  • It limits your risk
  • Offers more favourable interest rates
  • Can be paid back over a long time
  • You are likely to be able to borrow a significantly larger amount
  • Because secured loans are less risky from the point of view of a lender, they tend to be more flexible if you miss an instalment or are late on a payment.

The Cons of Secured Funding

Secured loans do have their downsides too. The loan amount will be limited according to the value of the assets you are willing to pledge as collateral.

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Unsecured Funding

An unsecured loan is another option that business owners can consider when looking for financial assistance.

The obvious draw of this alternative is that, as a borrower, you won’t be expected to provide collateral to receive funding. Unsecured loans tend to be a viable option for those with a solid credit score.

Depending on the loan terms, if the borrower defaults, the lender can pursue legal action or have a debt collection agency chase you for payment.

In some cases, a personal guarantee might be required, enabling the lender to seize personal assets if the business defaults on the loan.

The Pros of Unsecured Funding

Unsecured loans are a great option for those who need a smaller cash injection fast.

They are also less restrictive as the loan isn’t bound by an underlying asset. Business owners don’t need to provide collateral which also speeds up the appraisal process. 

The Cons of Unsecured Funding

The negative aspect of opting for an unsecured loan is that they tend to be more expensive because of the associated interest rates and have shorter repayment periods. 

For these reasons, it is also harder to qualify for one. 

South African business owners will need to show lenders that the business is fairly well-established, produces predictable revenue and has a positive cash flow. 

The lender is also likely to run a personal credit check on you. 

What’s more, defaulting on an unsecured loan can have dire implications and lead to financial ruin and damage the business owner’s credit rating. 

It is, therefore, really important to be confident in your business before you apply. 

The lender, instead of pursuing the assets will have to enforce a liquidation or wind-down of the business to try to recoup their losses.

It's important to realise that while they are unsecured against specific assets, they can still pursue the unencumbered assets of the business. It is not without risks

Final Thoughts

For entrepreneurs in South Africa who are just looking to get started with business loans, a secured business loan is likely to be their best bet. In fact, it may even be the only option. In contrast, if your business has been up and running for a while, and you’re taking a loan to expand the enterprise.

An unsecured loan might be worth considering, especially if you need a small amount of money fast and are willing to pay higher interest rates for the privilege.

While unsecured credit offers greater flexibility and faster access to more cash, it is important to acknowledge that the risks involved can be bigger for the business owner.

Business owners in South Africa who want to find responsible financing options should speak to the knowledgeable team at Geddes Capital for expert insights.

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