The Collateral Reality Check

How Lenders Actually Think About Collateral

Lenders aren't asking "what is this worth?" They're asking "what can I recover if everything goes wrong?"

That's a fundamentally different question.

A few concepts to understand:

• Book value is what's on the balance sheet

• Fair market value is what a willing buyer would pay a willing seller

• Liquidation value is what the asset fetches in a distressed sale, often at auction, with limited marketing time.

Lenders care almost exclusively about that last number.

They assume worst-case timing and conditions. They picture a bankruptcy auction, not a strategic sale. That $500K piece of equipment? In a fire sale scenario, it might bring $150K.

And here's the kicker: lenders don't even lend against the full liquidation value. They apply an "advance rate," lending only a percentage of even that discounted number.

This is why collateral coverage often comes up short in deals where the buyer assumed they had plenty of assets to work with.

Asset-by-Asset: What Lenders Actually Credit

Not all assets are created equal in a lender's eyes. Here's how they typically view different asset categories:

Tier 1: Assets Lenders Love

Accounts Receivable

A/R is often the strongest collateral in a deal. Lenders typically advance 80-90% against receivables under 90 days old. But they'll scrutinize:

• Aging (anything over 90 days gets heavily discounted or excluded)

• Customer concentration (if 40% of A/R is one customer, that's a risk)

• Historical collection rates

Real Estate Owned by the Business

Strong collateral when it exists, but many acquisition targets are asset-light with leased facilities. SBA will take a lien on business real estate but doesn't require it to approve a loan.

Cash and Liquid Securities

Obviously excellent collateral. Also rarely sitting around in meaningful amounts in businesses being sold.

Tier 2: Assets with Moderate Value

Inventory

Lenders view inventory differently depending on its form:

• Finished goods: strongest (50-65% advance rates)

• Raw materials: moderate

• Work in progress: weakest (hard to liquidate partially completed products)

Perishability, obsolescence risk, and fashion/seasonality all factor in. A distributor's inventory of standard industrial supplies gets treated very differently than a retailer's seasonal merchandise.

Equipment

Age, condition, and specialization all matter here. The key question: how easily can this be sold to someone else?

• General-purpose equipment (commercial ovens, standard trucks, forklifts): better treatment

• Highly specialized or custom equipment (proprietary manufacturing systems, industry-specific machines): heavy discounts

Typical advance rates run 50-75% of orderly liquidation value, which itself is already well below fair market value.

Titled Vehicles

Fleet vehicles generally get credited well because they're easy to value, easy to repossess, and have an active secondary market.

Tier 3: Assets Lenders Largely Ignore

Furniture, Fixtures, and Leasehold Improvements

That $200K buildout the seller did? Essentially worthless as collateral. You can't rip out leasehold improvements and sell them.

Goodwill and Intangibles

Here's the sad truth for acquisitions: goodwill and intangibles often represent 50-70% of the purchase price, yet lenders assign zero collateral value to them. You can't liquidate a reputation or customer relationships.

Customer Lists, IP, Proprietary Processes

Valuable to the ongoing business, but a liquidating lender can't auction off your customer list for meaningful recovery.

The SBA Collateral Difference

SBA loans operate under different rules than conventional financing, and this matters significantly for collateral.

The key distinction: SBA cannot decline a loan solely due to lack of collateral if the cash flow supports repayment.

This is a big deal for acquisition financing where goodwill comprises most of the purchase price.

However, SBA still requires lenders to collateralize "to the maximum extent possible." In practice, this means:

• Taking liens on all business assets regardless of value

• Considering the equity in the business itself (including goodwill) toward collateral requirements

• Potentially requiring liens on personal real estate when equity exists and there's a collateral shortfall

The 75% government guarantee fundamentally changes the risk equation. A conventional lender retains 100% of the loss if a loan goes bad. An SBA lender? They're only exposed to 25% of the loss. This is why SBA lenders can be more flexible on collateral.

So "I don't have much collateral" isn't an automatic disqualifier for SBA financing - it matters much more on the conventional side.

Alternative Collateral Strategies

When traditional business assets fall short, there are other ways to strengthen your collateral position:

Personal Guarantees

The baseline requirement for virtually all acquisition financing. Understand the difference between unlimited guarantees (you're on the hook for everything) and limited guarantees (capped at a specific amount or percentage).

Spousal Guarantees

Typically required when a spouse owns 20%+ of the acquiring entity or in community property states. Plan for this conversation at home before you're deep into a deal.

Cross-Collateralization

If you own other businesses or assets, lenders may look at pledging those to support the new acquisition.

Additional Real Estate

Bringing personal real estate or investment properties into the collateral package can meaningfully strengthen a marginal deal.

Seller Financing on Standby

A seller note on full standby (no payments until the senior loan is satisfied) effectively reduces lender risk. This can substitute for hard collateral in many situations.

Life Insurance

Often required anyway, but key-person policies can provide additional collateral value.

Third-Party Guarantees

Bringing in a financially strong partner or investor as a guarantor can bridge collateral gaps when your personal balance sheet isn't sufficient.

Practical Takeaways

A few things to keep in mind as you evaluate deals:

1. Get realistic about collateral early. Before signing an LOI, understand what a lender will actually credit. Don't rely on the CIM's asset values.

2. Know your personal balance sheet. Lenders will look at your personal assets as part of the overall picture on SMB (and sometimes LMM) deals. Be prepared for this.

3. If you're short on collateral, lead with cash flow. Strong debt service coverage can overcome collateral gaps, especially on SBA deals.

4. Structure seller financing strategically. A standby seller note can bridge collateral shortfalls and make a deal financeable.

Consider ordering appraisals. For equipment-heavy deals, getting a third-party orderly liquidation value appraisal eliminates guesswork.

The Bottom Line

Collateral is about lender recovery in a worst-case scenario, not about what assets happen to exist on a balance sheet.

Understanding this upfront prevents surprises at the finish line and positions you as a buyer who understands how financing actually works. That credibility matters when you're asking a lender to write a seven-figure check.

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