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Collateral and Credit
By: Dale Van Eckhout
Senior Area Manager, Bismarck Area Office
North Dakota District Office
What is required to obtain financing for my business? Lenders consider each unique situation, however they will look at some variation of the five C’s of credit and “collateral” (one of the 5 C’s) is still a basis for most loans made. Collateral serves as a secondary means of repaying the loan. The lender does not want to own the collateral and wants the business to succeed. The borrower must put their assets (collateral) at risk or in other words have “skin in the game” in order to obtain the needed financing for their business. Collateral includes assets such as real estate and office or manufacturing equipment. Accounts receivable and inventory may be pledged as collateral. Collateral may also include personal assets and commonly, a second mortgage on a home. Before approaching a lender, you should assume that all assets financed with borrowed funds will be used as collateral for the loan. Depending on how much equity is contributed toward the purchase of these assets, the lender may require other assets as collateral.
For purposes of valuation of collateral in the loan process, an appraisal must be completed by an independent professional. When a real estate appraisal is completed, it must be performed pursuant to regulations under FIRREA and the appraiser must utilize professional standards USPAP (Uniform Standards of Professional Appraisal Practice) . The North Dakota Real Estate Appraiser Qualifications and Ethics Board www.ndreab.org has lists of those qualified to complete needed real estate appraisals. A certified general appraiser can complete real estate appraisals as required if the amount being financed is greater than $250,000.
The SBA requires a business valuation when there is a change of ownership of the business. If the amount being financed minus the appraised value of real estate and/or equipment being financed is $250,000 or less, the lender may perform its own valuation of the business. If the amount being financed minus the appraised value of real estate and/or equipment is greater than $250,000 or if there is a close relationship between the buyer and seller, an independent business valuation from a “qualified source” must be obtained. A “qualified source” can include any of the following:
(a) Accredited Senior Appraiser (ASA) accredited through the American Society of Appraisers;
(b) Certified Business Appraiser (CBA) accredited through the Institute of Business Appraisers;
(c) Accredited in Business Valuation (ABV) accredited through the American Institute of Certified Public Accountants;
(d) Certified Valuation Analyst (CVA) accredited through the National Association of Certified Valuation Analysts;
(e) Accredited Valuation Analyst (AVA) accredited through the National Association of Certified Valuation Analysts.
Once an appraisal and/or valuation is completed, the lender will “discount” the collateral based on their policy. As an example, real estate may be discounted at 80% (i.e. $500,000 value X 80%= $400,000 discounted value). Normally a loan cannot be made unless the discounted value is equal or greater than the loan and adequate collateral is required as security on all SBA loans. However, an SBA loan request is not to be declined solely on the basis of inadequate collateral. In fact, one of the primary reasons lenders use the SBA-guaranteed program is for those small business applicants that demonstrate repayment ability but lack adequate collateral to fully repay the loan if the loan defaults.
For all SBA loans, personal guaranties are required from every owner of 20 percent or more of the business, as well as from other individuals who hold key management positions.
As you can see, collateral is an integral part of financing and as such, the word “collateral” is written 272 times in the Standard Operating Procedure governing loan processing for SBA. Should there be any questions, please contact any of our SBA offices.
Dale Van Eckhout has been the Bismarck area manager for the U.S. Small Business Administration since 2011, having formerly been Business and Cooperative Program Director and District Director for USDA Rural Development. He is a Certified Economic Development Professional and received Accreditation from the American Society of Farm Managers and Rural Appraisers. He can be reached at firstname.lastname@example.org.