What is my Collateral Worth? | Finance > Financing & Credit from AllBusiness.com
Facebook Twitter Google+ You Tube RSS Feed

What is my Collateral Worth?

When requesting a loan, a lender must place a value on your assets (collateral). Soft assets like accounts receivable and inventory are sometimes difficult to borrow against because a lender may not think your collateral is worth what you do.

More
There are as many different types of loans as there are types of assets. When looking for a loan for your business you should try to match the asset type to the type of loan you are requesting. Long term assets such as real estate and equipment make the best collateral for long term loans. Short term assets such as accounts receivable and inventory work best for short term loans.

 

How a lender values collateral is really not a mystery, but the value you place on it may not be what a lender thinks it is worth. In the case of real estate and equipment, a certified appraiser estimates its value using several customary methods and the lender loans XX% of the appraiser’s valuation.

 

Things get a little grey when it comes to “soft” collateral such as accounts receivable, inventory, purchase order and contracts. Recently I spoke to a small business owner who wants to borrow against his inventory in order to buy more products so he can make more sales. His product is very unique, a one of a kind miracle cure for middle aged men and women. He is sure that once it hits the market it will ‘sell like hotcakes’. Listening to him describe his product I could tell that not only was he excited about what the product could do, but was sure he’d hit upon a gold mine.

 

As he explained how things worked I asked about the numbers. Well, ….  he starts to explain, he will sell each unit of product for $40. The really impressive part is that it is only going to cost him $2 to make each unit. He has 20,000 pieces of product so far in his warehouse. The big question is how much can he borrow against his inventory?

 

  1. $800,000
  2. $  40,000
  3. $  20,000
  4. $  10,000

 

To the owner, he believes his inventory is worth A. $800,000.  That is, after all, what he plans to make selling his product. But to a financial lender, his inventory is worth somewhere between C & D, if he is lucky.  The actual cost of the inventory is $40,000, but if the lender is going to lend against it, he will have to calculate what he would be able to sell the inventory for if the small business owner defaults on the loan. This value is often referred to as the salvage value by lenders. For some products the salvage value is often only pennies of the original cost.

 

The more unique the product is the harder it will be able to sell.

 

Inventory products that are manufactured for other companies and use their name and trademark are nearly impossible to value as collateral. I once had a customer that manufactured laptop carry cases for Dell Computer. They had Dell’s name all over them. The snaps were stamped with Dell’s logo. My customer was being asked to manufacture them and inventory them for Dell, but Dell made no guarantee to purchase any inventory other than what they actually needed. If my bank was to lend against that inventory as collateral and if the borrower defaulted on it, the only party who could legally buy the inventory is Dell. Even though my customer had great expectations that Dell was going to treat him well, my lender couldn’t make the loan because of Dell’s trademarks on the carry cases. If they had been plain black carry cases the story would have been different.

 

When borrowing against your company’s soft assets you need to think like a lender. It’s not what the collateral is worth to you; it is what it is worth to the lender that matters.


Sam Thacker is a partner in Austin Texas based Business Finance Solutions.

You may contact Sam directly at: sam@lesliethacker.com

or follow him on Twitter: SMBfinance

 

EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his Ask the Expert podcast show.

Newsletter

Weekly Roundup

Sign up for our weekly Experts roundup, delivered to your inbox each Saturday morning.

Most Recent From our Experts

AllBusiness Experts
;
Close

Real Business Owners, Real Business Advice!

Sign up for practical, real-world solutions from successful business owners delivered to your inbox each Saturday morning. FREE.