Crafting Debt Offers – Secured Debt / Collateral

In most instances, the maker of a loan will seek to secure payment by requiring that the small business identify an asset as collateral. In the event that the small business is unable to pay the loan pursuant to its terms, then the lender may take the collateral, sell it, and apply the sales proceeds toward payment of the loan.

?When considering an application for a loan, the small business should be prepared to consider the request for collateral. In some instances, this request is straightforward in that the small business plans to use the loan to buy an asset, such as a building or equipment, which becomes the collateral. In other instances, the lender seeks additional assets to ensure that under any situation it will be able to raise enough money from the sale of the assets to pay off the loan.

?When a lender must foreclose on a loan and sell collateral, it must abide by laws regarding how the sale is conducted. It must publish the event of the sale to generate interest. However, it is common that a sale of foreclosed property will result in a price that is below market value. The market value of an asset may be further reduced because the asset is no longer new and considered ‘used’. In the same way that driving a car off of the sales lot may cause an immediate 20% reduction in value, the lender must anticipate an even lower value of an asset when it is sold through foreclosure. In addition to the projection of a reduced value, the lender must account for their cost in completing the seizure and sale of the asset. For all of these reasons, lenders commonly seek total assets as collateral having a much higher book value than the amount of the loan.

?The requirement that the value of the collateral is higher than the amount of the loan often presents a challenge to the small business. The small business:

·?????? may not have other assets that can serve as collateral, or

·?????? may have other loans where other assets are already pledged as collateral.

Some lenders seek ‘blanket’ collateral in all assets owned by the business.

?A common mistake of entrepreneurs is to pledge their personal assets as collateral. In the event of a default on a loan, the entrepreneur may find themselves without a house or a car – homeless, unemployed, and restricted in their ability to get new employment. This sad situation may be compounded by divorce when the spouse bails on the marriage.

?Keep in mind that if a lender takes collateral and finds that its sale is insufficient to pay back the loan, then the lender can obtain a judgment for breach of contract, seize the assets of the business, and sell them off to pay the loan. The establishment of selected assets as collateral for a loan simply gives the lender priority over other creditors for that asset in the event of the failure of the business. The asset or the proceeds from its sale may not be touched by another lender or creditor until the original lender is repaid in full.

?The potentially catastrophic consequences of the forced sale of collateralized assets should be given serious consideration when considering a loan application. Small businesses should compare lenders and their collateral requirements. Pledging assets as collateral should be considered from the perspective of obtaining that particular loan and the impact on any other loan that the business may need to obtain before the term of the original loan ends.

?Example: A small business determines that it should obtain a loan for $100,000 to buy needed equipment. The small business may look to a bank, the vendor of the equipment, or an equipment leasing company to see which financing source has the least requirement for collateral.

?Exercise: If your small business currently is borrowing money from anyone for anything, review the provisions of the loan, if any, that provide for assets to be used as collateral. Determine the fair market value of the asset when compared with the outstanding balance on the loan. Then, assume that a foreclosure sale will obtain a price of only 50% of the balance on the loan. Consider the consequences of further action by the lender to obtain payment.

?Successful Funding Show

?Tuesday, I produced the second show of my Successful Funding on LinkedIn Live. ?My special guest was Harvey Tuck . We discussed franchising as a way of outsourcing funding as a way of growing a small business as well as different ways for franchisees to raise funding for the franchise fee, outfitting the business, and operating expenses.

The next Successful Funding show will be on Tuesday, February 6th. My guest will be Devin Thorpe , the founder and CEO of SuperCrowd. In this position, he runs an impact investment club and produces educational programs and events on creating impact through investment crowdfunding.

?The Successful Funding show will repeat weekly at 8 am MST on Tuesdays on my LinkedIn profile.

?To participate in a Successful Funding show, go to my profile on LinkedIn on Tuesdays at 8 am MST.

https://www.dhirubhai.net/in/karldakin/

?My first two shows are recorded and available for viewing on LinkedIn. You may find them in my Posts.

Don Cohen

?I appeared on Don Cohen’s Hour of Employer show last week where I was joined by Paul Banks and discussed ‘raising capital’.

?https://www.dhirubhai.net/events/7154911245358321664/comments/

?SuperCrowd 2024

?I will be co-hosting the SuperCrowd 2024 event: “The Impact Crowdfunding Event of the Year” which will be held April 17th and 18th online.

?Early registration is now open and you can get deep pricing discounts over the day of the event tickets.

?I have been asked to make a presentation at Noon MST on April 18th where I will share examples of investment crowdfunding offers I have designed that are targeted to small business customers.

?https://thesupercrowd.com/supercrowd24

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Karl Dakin, the Capital Coach

Dakin Capital LLC

[email protected]

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