If you have managed to keep your small business afloat through the first year—or even the first two years, congratulate yourself for having accomplished what roughly 40% of business owners cannot. By now, it is time to initiate your plans for growth, and you may need lines of credit for that. But, which is going to be better for you and your business—secured or unsecured lines of credit?
Each has benefits and drawbacks, and suits some situations better than others.
Unsecured lines of credit allow business owners to retain control of their assets. On the other hand, secured lines of credit put business—and usually, personal—assets on the line. Those assets can be real estate owned by the company or the individual(s) named as the borrowers. It take a strong stomach to agree to hand over the home you share with your family if the business falls on hard times, and is often the single condition that makes business owners choose unsecured lines of credit.
Other assets used as collateral for secured loans can include business equipment, inventory or accounts receivable.
Banks are in the business of making money by lending money. Consequently, when the lions share of the risk is borne by the borrower—as is the case with secured loans—banks typically charge lower interest rates; when borrowers choose unsecured lines of credit, they may face higher interest rates. How high is determined by personal and business credit histories and the degree of promise shown in their business plans and indicated by past performance.
Besides secured or unsecured lines of credit, there is another option: credit cards. Many business owners finance their businesses with personal or business credit cards; however, this option should be considered as a last resort because credit card rates are higher than that of secured or unsecured lines of credit, and the interest can break a business.
Another drawback to financing with credit cards is that, unlike more traditional secured or unsecured lines of credit, they have a variable interest rate that can be suddenly adjusted upward (but rarely downward), and their limits can be suddenly reduced.