For business owners seeking finance, there are smarter unsecured funding options than using real estate as security.
Getting an overdraft secured against personal real estate is still central to the thinking of most would-be owners and managers of small and medium sized enterprises. They do this despite a multitude of offerings now available from non-bank unsecured lenders, invoice finance providers and fintech companies.
But, in the context of growing concern over property bubbles, it is prudent to reconsider the risks:
Given the relative ease of getting real estate secured funding, some business owners may not fully appreciate the pros and cons. But there is a simple thing to remember: owners should only pledge what they are prepared to lose. This means that the family home is ‘on the line’, exposed to the changing fortunes of the business. Each business owner will need to weigh up whether this is an acceptable risk, considering the volatility of the business world.
What goes up may come down
Property cycles are notorious for their ups and downs – and, despite common misconceptions, it is important to remember that real estate prices do not always rise. Stagnation in property prices – or, worse still, falling prices – may mean the business cannot get access to much-needed funds or continue growing. This can have serious consequences if the business cannot meet its obligations but also that opportunity cost can mean competitors get a leg up. By contrast, some solutions like invoice or debtor finance can grow with the business to avoid such situations.
You could get burnt in a fire sale
Business fortunes can change quickly – remember the dotcom crisis and the global financial crisis? In a worst-case scenario, you may have to shut your doors. That leaves the home and the family exposed if real estate has been used to secure business loans.
Homes often have to be sold in such circumstances and, inevitably, it may involve a fire sale in which the property is sold at short notice and at lower than market value. Unsecured business funding removes such a danger.
Secured overdrafts add complexity to funding scenarios
Even if there is no forced property sale, personal lending scenarios can become far more complex in cases where real estate is used as security for business funding. For example, such a facility can often make it more difficult for a family to move home or upgrade as the security is already tied up in the business. Invoice finance allows business owners to separate their commercial and private assets and makes for a more straightforward situation where the business is effectively self-funding.
Secured finance – It just doesn’t add up sometimes
While using real estate to secure business funding may be dangerous, there is no doubt that equity in a home can be used for other smart financial purposes. Investing in shares; buying additional property; getting a small loan for other family requirements – there are a range of possibilities.
However, risking your home when all a business may need is a simple line of credit from a reputable debtor finance provider makes little sense, particularly if the business is not the best performing investment.
Questionable value of property-secured finance
Then there is the issue as to whether the bank is offering good value for your security, such as the highest possible loan-to-value ratio. Don’t count on it. Depending on the bank’s credit appetite, they may want an unreasonable amount of security which means they may end up being ‘oversecured’. This can become problematic from a business perspective as a bank having too much security may prevent the business from accessing additional funding from another lender who will require the primary lender to release part of their security, which they may not wish to do. This can lead to significant opportunity costs as well.
There is also every chance when real estate is used as property security that the value of a business’s funding will not grow in line with its needs. Why? It’s because the value of the underlying security – in this case property – may not keep pace with the business’s working capital requirements. What happens is that business outgrows its facility, or is constrained by it. Why should a business’ growth be constrained by the property market which has almost nothing to do with the business?
Consider unsecured finance options, such as Invoice Finance
What is invoice finance? It is a viable form of unsecured business finance whereby an enterprise can get an on-demand line of credit secured by one or more outstanding sales invoices. A typical facility will advance 80 per cent of the value of receivables. So, for example, $400,000 would be available against a ledger of $500,000 and so on.
Best of all, invoice finance allows businesses to escape the pitfalls of property security.