Secured Business Term Loan
What is a Secured Business Term Loan and when is it the best funding solution for an SME?
A loan is the most obvious choice when an SME is looking to expand its business, survive a downturn, or buy an asset and it needs capital to achieve its goal. Lenders usually have a cap on the amount they are prepared to lend through an unsecured Loan. If you need a higher amount or if you want better terms, applying for a Secured Business Term Loan could be the solution if you have an unencumbered asset that can be pledged against it.
A Secured Business Term Loan is a loan where the borrower pledges an asset against a debt, the pledged asset is called the collateral. Usually, a secured business term loan has a lower interest rate than an unsecured one. A borrower with a poor credit rating is more likely to get a Secured Business Term Loan because they have unencumbered collateral that can be used to secure the loan. If the debt is not repaid, the lender may claim the secured assets.
A Secured Business Term Loan should be obtained with appropriate planning of funds and resources to avoid losing your collateral if it becomes difficult to keep up with the repayments. Appropriate consideration should also be given to the value of the collateral. A depreciating asset will be appraised as collateral based on the estimated value at the end of the loan rather than on the market price at the beginning of the loan. Also, if there is a huge drop in the market value of the collateral, and therefore it would not ‘secure’ the loan anymore, the lender may ask for more assets to be pledged to continue ‘securing’ the loan.
Most Common Assets Pledged
The collateral is the most important aspect of a Secured Term Loan because it reduces the risk to the lending company, therefore reducing the interest rate the borrower pays. The most common assets used as collateral are real estate, machinery, vehicles, shares, and other similar resources. Some lenders accept fine art or jewelry but they are deemed to be less easily disposable and their value may go through extreme fluctuations. so they are not the most common choice for collateral. Obviously, the borrower must own the asset unencumbered.
It is possible to ask the lender for permission to replace the pledged asset with another equally acceptable one. This allows a borrower to sell or replace an asset originally used as collateral just by replacing it with something else of equal value and equally unencumbered before they sell the assets originally pledged as collateral.
Secured Business Term Loan vs. Unsecured Term Loan
Most people are not keen to risk an asset and would rather try to apply for an unsecured loan first. But, there are advantages to a Secured Term Business Loan, advantages that may be higher than the risk of losing the asset if the loan is part of a specific business strategy, and it is planned and managed appropriately.
If the business has a limited track record (e.g. a start-up in need to buy equipment), or the principals in the business have a poor credit record, it is easier to obtain a secured loan. Lenders are more inclined to agree to a larger amount at a relatively lower cost than what they would do for an unsecured loan, and – last but by no means least - usually secured business loans are repaid over a longer period resulting in lower monthly payments.
Everything else being equal, the deciding factor is whether the (probable) lower rate and other advantages of a Secured Business Term Loan are worth the risk of losing all or part of the collateral if the circumstances of the borrower change and it is not possible to meet the repayments anymore.
Secured Business Term Loan vs Business Credit Line or Invoice Finance
A Secured Business Term Loan gives you a lump sum which you will repay on a regular monthly payment for a certain period of time. It is better used for a specific purpose (as mentioned earlier, buying a specific assert, securing capital to survive a downturn, etc.). It could potentially be renegotiated but there is no flexibility, the terms and the repayments are set at the beginning and do not change unless the loan is renegotiated.
A business credit line is a flexible credit that is used as needed and repaid randomly. Each time a lump sum is paid back the availability of the credit line is increased by the amount paid back. Interests are only charged on the amount outstanding at any given time. Interests increase the total amount owed and there is no obligation to pay everything back until the end of the agreement.
Invoice Finance is a loan based on the value of invoices issued to clients, its terms are more related to the creditworthiness of the clients than the one of the business applying for it. The borrower is lent a percentage of the amount of the invoice(s) billed but not paid yet and when the client pays, the last payment from the finance company is reduced by the interest and fees charged for the amount of time that those specific invoices have been financed. The process is repeated with the next round of invoices.
If you need a specific sum for s specific purpose a secured business term loan is a way to get finance at a cheaper cost, repayable in a relatively long period. On the other hand, if you need help in periodically supporting your cash flow then you may be better off looking into one of the more flexible solutions described in this section.
Shopping for a Secured Business Term Loan
A Secured Business Term Loan is a loan, so the same as for any other type of loan apply: Shop around. Once you have selected several lenders that offer the loan you want for the time you need and at an interest rate you can afford, you need to look if they are registered with your local financial regulator, in Singapore the Monetary Authority of Singapore (MAS). This is important because an entity supervised by the MAS needs to follow a number of rules that include, among other things, acting in the best interest of a client.
The next step is to look out for fees, charges, and repayment flexibility. What happens if one month you are late? Is it possible to change the day of the monthly payment if you have a cash-flow issue? Under what condition will the lender take possession of the collateral?
The borrower should consider the likely evolution of the business during the life of the loan and make sure there is a system in place to forecast cash-flow issues in time to discuss a solution with the lender to avoid losing the asset given as collateral.
An asset rich SME can use a Secured Term Loan to survive a downturn without disposing of any assets if there is a reasonably good chance of being able to meet the monthly payments until the loan is paid back.
Singapore Government support to SMEs
As part of measures to help SMEs during the COVID crisis, the Monetary Authority of Singapore (MAS) and Enterprise Singapore launched a new facility to lend Singapore dollars at 0.1 percent interest per annum to eligible financial institutions on 20 April 2020. Eligible financial institutions are expected to pass on the cost savings, to make more loans to SMEs at a lower cost since SME loans are priced based on the risk profile of the borrower and the cost of funds.
This initiative adds to two existing other existing schemes that were included in the Solidarity Budget 2020 : the SME Working Capital Loan and the SME Micro Loan.
The SME Working Capital Loan is a government-assisted financing loan under the Enterprise Financing Scheme (EFS WCL). It helps SMEs access financing until March 2021. Under this scheme, SME will be able to access up to SGD 1 million to finance cash flow needs. Enterprise Singapore partners with 15 financial institutions with up to 90% risk-sharing. Credit criteria and interest rates depend on each one of the 15 institutions. SME borrowers are still liable for 100% of the loans. In the event of the default, banks will proceed first with their standard commercial recovery process before relying on the government risk-sharing program.
Enterprise Singapore eligibility criteria for the scheme are:
- Local business registered and operating physically in Singapore.
- Group annual sales not exceeding SGD 100 million or group employment size not exceeding 200
- Minimum 30% ultimate ownership held by Singaporeans or Singapore Permanent Resident
Only 9 institutions participate in the SME Micro Loan, another government-assisted financing scheme to help local SMEs access financing. Enterprise Singapore will provide risk-sharing. The scheme allows eligible SMEs to access up to SGD 100,000 working capital. The loan can be used to manage daily operations and cash flow.
The eligibility criteria are:
- Company registered and operational in Singapore
- Annual sales turnover not exceeding SGD 1 Million, employment size not exceeding 10 employees
- Minimum 30% local shareholdings (Singaporean or Singaporean Permanent Resident)