100% Collateral - The ultimate absurdity in startup loans

I’ve heard of it before, but not often. It’s the “100% Collateral loan” and it works like this:

The bank says they will give you the loan IF you can provide collateral in the amount of the loan. In the example I heard recently, the new business owner was asking for a loan in the amount of $80,000. She had a home and a mortgage of $60,000, which means she had $20,000 in equity (ownership) in the home which she could use as collateral. She figured that this 25% collateral would be enough. But the bank said, “Because you are a startup, we require 100% collateral - $80,000.”

So my question in these circumstances is this: If you had $80,000 in funding for your startup, why would you need a bank loan? There may be lots of circumstances in which you would not want to sell or use these funds (If they were in a 401L, for example), but what if you had the cash?

In this instance, the person could have taken out a second mortgage to get the $20,000, but she didn’ t have enough equity to cover the entire $80,000. I encouraged her to seek funding elsewhere. At another bank, the 25% collateral might have been enough.

Over the years I have been counseling new business owners, I have to say that the one big unknown is banks. I have seen banks give loans that even I thought were risky, and I’ve seen banks deny “sure thing” loans in which the borrower had tons of good collateral.

In this case, I think the bank was terrified of making this loan and losing it, but another bank might not be so conservative.

If you’re seeking a loan, and the first bank turns you down or demands something unreasonable (like 100% collateral!) walk away and go find another bank. I will guarantee you that there’s another bank out there that will take your loan gladly.

If you need more information about startup loans, look in the Sources of Funds chapter in Planning for Practice Success.