Collateral is an important part of many business financing solutions. It helps the lender reduce the risk associated with providing financing and can have a significant impact on the type of financing a business receives and the terms it is offered. While collateral may seem complicated, the basic idea is actually quite simple. In this article, we explain what collateral is, why it is used, what lenders evaluate, and what types of collateral are available for businesses.   

Why is collateral needed?  

When a bank or another lender provides financing to a business, it always takes on financial risk. Even if a business appears financially stable today, no one can predict the future with complete certainty. Sales may decline, costs may increase, or market conditions may change unexpectedly. 

The purpose of collateral is to reduce this risk for the lender. If the business is unable to repay the financing as agreed, the collateral allows the lender to recover part of the remaining debt. 

Having sufficient collateral can significantly improve the financing terms. It can make it easier to obtain financing and directly affect how much financing the business can receive, the interest rate offered, and the repayment period. 

However, collateral alone does not determine the financing decision. Lenders primarily assess the business itself, including its financial position, cash flow, and ability to repay the financing. Collateral serves as a safety net and is only one part of the overall assessment used to make the final financing decision. 

What types of collateral are used in business financing? 

Collateral in business financing can be divided into three main categories: tangible collateral, personal guarantees, and public guarantees. Business financing can be secured with a single type of collateral, but it is common to use a combination of different forms. 

Tangible collateral 

Tangible collateral refers to assets that have measurable financial value. Examples include real estate, business premises, machinery, equipment, vehicles, and other valuable assets. 

A business mortgage is also considered tangible collateral. It is one of the most common forms of collateral for small and medium sized businesses. A business mortgage allows a company to use its movable business assets as collateral, such as machinery, equipment, inventory, and, in certain cases, accounts receivable. It covers the company's business assets as a whole, so individual items do not need to be pledged separately. 

Personal guarantee  

In business financing, a personal guarantee usually means that the entrepreneur or another individual agrees to be personally responsible for repaying the financing if the business cannot do so. 

Personal guarantees are especially common for new businesses that have not yet built up enough assets to offer as collateral. Although the financing is granted to the business, the guarantor is ultimately responsible for the debt with their personal assets. For this reason, it is important to carefully review the terms and responsibilities before signing a personal guarantee. 

Public guarantees 

Not all businesses have enough tangible assets to provide as collateral. In these situations, a public guarantee can support the financing application. The best known example in Finland is a Finnvera guarantee. 

Finnvera can share the credit risk of the financing with a bank or another lender. This can make it easier for businesses to obtain financing when investing, expanding, or covering working capital needs. It is important to remember that a public guarantee does not remove the responsibility of the business or the entrepreneur to repay the financing. Instead, it complements the company's own collateral when it is not sufficient on its own. 

Can a business get financing without collateral? 

Not every business owns real estate, valuable machinery, or other assets that can be used as collateral. However, this does not automatically prevent the business from obtaining financing. 

Many financing solutions today do not require tangible collateral. This means the business does not need to pledge physical assets. Instead, the financing decision is based on the company's financial position, stable cash flow, and creditworthiness. In many cases, a personal guarantee from one or more entrepreneurs is sufficient. 

In some situations, it is also possible to obtain financing without any collateral or guarantees. However, the available financing amounts are usually smaller, and the interest rate may be higher. The right solution always depends on the amount of financing needed, the company's financial situation, and the intended use of the funds.