From UPS to Walmart, America is filled with stories of entrepreneurs who took a small personal loan and turned it into an empire. Sam Walton famously started his retail franchise based on a $20,000 loan from his father in law—a risk that paid off for both parties. That was 65 years ago, but today's credit crunch has led many businesses to seek creative ways of financing. That often includes asset loans, which let the borrower put up some personal property as collateral. Borrowing against your own property—whether that's a fleet of company vehicles or a prized baseball card collection—can be hazardous if not done properly. That said, it might be the only choice for some new businesses.
"You need capital to get things going. It's tough if you don't have a track record, if you don't have a business, to find outsiders to believe in your concept," says Tom Taulli, a tech adviser, blogger, and author whose books include a handbook on buying, selling, merging, or valuing a business.
How exactly is it done? We asked financial experts about what to look out for to make sure your personal assets don't get whisked away before you know it.
Using Personal Asset Loans: Why Seek an Asset Loan?
If you're thinking you need to borrow against some of your property—whether personal or professional—you're not alone these days, Taulli says. While the country seems to have been recovering from the economic downturn, people are more likely to turn away from banks and more toward family, friends, angel investors, or other local sources for a loan. But you still need to put something on the table to guarantee the debt, Taulli says.
"With the housing crisis, people don't have the kind of assets they used to have," he says. "A lot of personal loans are from family and friends. They're not as rigorous. It may be more like: I'll pledge my car, baseball card collection, whatever. The bank probably just wants real estate at the end of the day."
Mitch Jacobs, founder and CEO of On Deck Capital, which helps small businesses get financing, says the condition of borrowers overall has declined recently, meaning entrepreneurs sometimes have no choice but to put up something to show they have faith in their own business plan.
"There's more unemployment, periods where people have holes in their income, there's people who don't have steady salaries," he says. "That tends to put people in a little bit of a credit crunch. If they need financing, they leverage assets a little harder."
When you put some assets on the table, it shows the lender you believe in your business, even if this is your first entry into the market.
"If you've got a complete start-up that hasn't sold anything yet, it's going to be hard to get a loan," says Dan Drechsel, CEO of FTRANS, a company based in Atlanta that helps small businesses manage cash flow. "There's got to be some track record."
Start-ups also benefit from these kinds of loans because they save lenders the effort of creating a full financial forecast for the company—an often time consuming task that's sometimes impossible for a new company.
"If the business doesn't have a clear financial picture, then an asset based loan can be an easier way to access capital," Jacobs says.
Using Personal Asset Loans: What Property is Useful?
The simplest and most common form of an asset loan is found in just about every city—the pawnshop. Odds are, your business is looking for something more legit. Experts say your better off considering these asset options before you pawn your laptop.
Much like a home mortgage, borrowing against a property is an easy way to generate collateral. "If a business happens to have property—building or land—that's first," Drechsel says. But most start-ups are lucky to have even have their own rented office space, so there might not be much property to speak of yet.
Lenders look for things they can liquidize quickly and easily in the case they have to collect to repay the debt. Equipment can also be difficult for new companies to offer as collateral, but the category can include anything from construction machinery, company vehicles or manufacturing equipment.
Jacobs says to make sure anything you consider is valuable and easy to monetize. Something like medical equipment is easily marketable and quickly liquidated, he says. But if a collection of many smaller pieces of equipment—even if it has a lot of combined value—may not be of much interest to a lender.
"A lender needs to think about how they're going to monetize that collateral," he says.
Basically, if it's something where the value is easily understood, it will be more attractive to lenders, says Marie O'Brien, president of the Development Authority of Connecticut, where a statewide angel investor tax credit was recently adopted.
"Usually with that kind of fixed asset, which is a much more tangible item, you can have an appraisal on it of economic value," she says. "That's readily understood and frankly more tradable in any market and any economic condition."
- Personal valuables.
If you're trying to come up with something to leverage in an asset loan, Taulli says to think creatively. "You probably have more assets than you think you have," he says. Those assets can be anything of value: your family heirlooms, gold jewelry, or sports collectibles. But remember: anything you put up as collateral is at risk. "That's the first question you have to say is 'Can I live without this?' " he says. "If the thought of having the business is more important than having that asset, then go ahead."
- Accounts receivable.
For most new businesses, receivables are the best asset to offer up for a loan. It's easy for a lender or a bank to take a position on the quality of receivables, O'Brien says. "They have a high value to the bank, a high value to any lender," she says.
A lender will look at the reliability of the person paying the receivables, Jacobs says. Lenders will look favorably if you're borrowing against money coming in from a big company like Walmart, which usually pays on time. But lenders may have less confidence if you're counting on money coming from a smaller company that might not be as credit worthy.
Protecting Personal Asset Loans: How to Cover Yourself
Wagering your personal assets on your business comes with no shortage of perils. Certainly there are people who have lost their homes when businesses went bad. Experts offer these tips to protecting yourself before entering into a loan.
- Make the loan agreement restrictive.
Taulli says you should clearly define what qualifies as a "default" and how long you have to cure the debt. The agreement should also state that it applies only to the specific piece of property. "If the property is not enough to take care of the outstanding loan, they can't go after other properties," he says.
- Set up a corporation.
Even if you're a one-person business, setting up a corporation can create a barrier between your debtors going after all your worldly possessions. The agreement will be between the lender and the corporation, not between you and the lender. "It provides a level of protection from personal assets," Taulli says.
- Have a good credit score.
Especially if you don't have a ton of assets to leverage, lenders will use your personal credit score as a shortcut to learn about your risk potential instead of spending 100 hours researching your small loan request, Jacobs says. That means they'll be looking at your mortgage and other household debt on top of your business record.
- Be wary of personal guarantees.
A personal guarantee can turn into what some professionals call "unlimited collateral." A lender may require you to sign a personal guarantee before they release money, but experts say to avoid them when possible. "If you're putting your personal guarantee on this stuff, and your business doesn't work, they're going to come after you personally," says Joe Harpie, chief lending officer for the Connecticut Development Authority. "If you have to put your personal guarantee on top of it, it would be very difficult to separate yourself away from your company," he says.
- Keep thorough documentation.
Even if the loan is from family or friends, Taulli advises keeping good documentation of the agreement clearly stating the terms and timeframe of the loan. "You want to run it like a business, make it feel like a business, and make sure everyone's expectations are in line," he says.
- Don't borrow what you can't pay.
It's an obvious tip, but one worth stressing, Drechsel says. "Protecting yourself is not borrowing money you might lose," he says. "The terms and conditions and the other things involved are going to be structured in such a way that they're going to be paid back. If the business can't generate the money to pay the money back, then don't borrow the money."
Jacobs says to be sure to research alternative funding sources, including small business loans, federal community development dollars or nonprofit groups such as Seedco, all of which can provide dollars without putting your personal assets on the line.