By definition, any loan backed by collateral is termed as a secured source of finance both short-term and long-term financing. The collateral can be a tangible or intangible asset for the company. However, most businesses pledge intangible assets such as property, land, or high priced equipment as collateral.
A common notion with Short-term financing is that it is often an unsecured form of debt. Most bank loans and private lending for the short-term do come without any collateral, but not all forms of these loans are unsecured.
What Is Secured Short Term Financing?
Any form of financing that comes with collateral and the borrowers can pledge something is secured financing. If the maturity period of the loan falls within 12 months we can term it as a secured short-term loan.
Liquidity and precisely working capital management is the biggest driver behind short-term financing for businesses. Some operational activities such as invoicing or payables can also take the form of secured short-term financing. Mainly any financing needs that fulfill the operating activities of a business related to the short-term financing category.
Characteristics of Secured Short Term Financing
Secured loans offer distinctive benefits to both the borrowers and the lenders. Below are the list of main characteristics of these loans:
- These loans are backed by collateral such as a tangible asset
- The maturity period of these loans fall within 12 months
- Interest rates for secured loans are usually lower than with unsecured loans
- These loans may come with fixed or floating interest rates
- Lenders may attach additional debt covenants with secured loans such as specific use of the assets
Secured loans offer more benefits to the lenders than the borrowers as they do not risk the borrower’s default. However, secured loans yield lower interest rate returns for the lenders too.
Some key implications with secured short-term loans for lenders and borrowers are:
- Borrowers can quickly access these loans as these are backed by collateral
- Borrowers can save on interest rates with secured loans
- Lenders can earn interest charges and may attach additional covenant to secure the investments
Sources of Secured Short-Term Financing
A company can use both internal and external resources to pledge against a secured short-term loan. If a company has an underlying asset (tangible or intangible), it can secure short-term financing. However, collateral is not the only prerequisite in loan approvals. The borrower’s credit history and creditworthiness play an important role in approving these loans too.
Some of the commonly used forms of secured sources of short-term financing are discussed below.
Secured Bank Loans
Usually, banks approve short-term loans without collateral as an unsecured form of financing. However, borrowers may reach a certain leverage level where banks require collateral for short-term borrowings too. Any short-term bank loans with a pledge can be categorized in the secured form of financing.
Line of Credit loans backed by collateral or even a revolving credit facility for the short-term can be listed as a secured short-term financing option. A line of credit differs in working nature from the RCF. A line of credit approves a one-time loan limit but the borrower cannot replenish the facility once withdrawn. Similar to the RCF, a line of credit also comes with high-interest rates.
Trade loans are usually more suitable for large companies having import/export facilities. However, many companies utilize these trade loans for their working capital management needs as well. These loans are short-term with a maturity of up to one year and also come with high-interest rates.
Borrowers do not pledge any company assets with trade loans. These loans are secured against the goods in transit, these goods can be domestic or international transits. Trade loans take the form of revolving credit facilities and lenders to secure the loans against documentary controls.
Private lenders also issue unsecured loans most commonly. However, much like short-term bank loans, these private lending platforms may also require a pledge at some stage. Any private borrowing from business angels or venture capitalists for the short-term can also be categorized in the secured financing options.
Factoring or more commonly known as invoice factoring is an internal source of short-term financing for any business. In this arrangement, a business outsources the collection of outstanding invoice balances to a specialist firm. The specialist firms usually approve up to a certain percentage of the total outstanding balance depending on approval criteria. The pledge against these loans is the invoices or accounts receivable balance that the company foregoes with the contract.
Grants and Government Schemes
Technically these sources are not loans but can play an important role in a company’s financing needs. Grants and government schemes can help a company meets its operational needs such as an important upgrade in technology equipment.
Secured loans also come with certain benefits and risks for both parties. Some of the common pros and cons of secured short-term loans are given below.
Pros of Secured Loans
- These loans come with collateral backing hence offer lower costs
- Backed loans get approves quickly
- Borrowers can use loans for all purposes without any covenants attached with secured loans
- Borrowers can use internal and intangible assets to secure these loans such as in invoice factoring
Cons of Secured Loans
- These loans always require any asset to pledge as collateral
- Interest costs may be higher than a long-term secured loan
- Borrowers may forefeet the pledged asset in case of default
- Maximum loan amounts approved may not be substantial
Secured and Unsecured Short-Term Financing Options
It is a common practice for borrowers to apply for short-term financing loans. Most of the loans take the form of unsecured loans. Both forms of loans offer certain benefits and limitations. Availability of the financing options, credit history, and collateral play as the deciding factors for the borrowers to choose from both financing types.
Both parties look for certain criteria when arranging for an unsecured or secured debt. Usually, with an available credit score and assets to pledge, both parties would prefer to arrange for a secured loan. However, unsecured loans for the very short-term do not require complicated documentary controls and often are a go-to option for small loans.
Secured loans with short-term maturity and backing with collateral can be the preferred choice for both parties. These loans come cheaper than unsecured loans. However, unsecured loans also come with quick processing and backing of the borrower’s creditworthiness.