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What Is Secured Business Lending?
Secured business lending is when borrowers have to put up assets as collateral on their loans. Those assets protect the lenders – in this case, I mean individual lenders like you and me, using P2P lending sites.
Assets are things of value like properties, machinery, equipment, cash or even invoices that the borrowers' customers are due to pay.
So, if a borrower can't repay the loan, those assets can be sold, and lenders can more easily recover all their money, as well as the interest due to them, including penalty interest.
Cards on the table
In peer-to-peer lending, secured business lending is something you should be very dubious about, as a starting point, when you are just about to look into the risks for a given peer-to-peer lending website.
There is clearly huge potential in secured lending and it can be incredibly effective at reducing the risks. But there are also some very weak forms of “security” for you that you need to beware of.
Some peer-to-peer lending sites that call their loans “secured” rely on this weaker, fluffier stuff as security.
Most so-called “secured business lending” in P2P is fluffy and thin. Typically in this case, the P2P lending site takes a “fixed-and-floating charge” on the business' assets.
Let's split that phrase into two. A “charge” is the means by which lenders take a right to an asset or property when a loan goes bad. So, if a borrower goes bust, the P2P lending site can claim those assets, sell them and repay lenders.
That sounds good, right?
But “fixed-and-floating” means that you are just entitled to whatever assets the business happens to have at the time when the loan goes bad. So the business is able to use, use up, or rundown all those assets from the point the loan is taken out until the borrower is broke.
There could be no assets left by the time that happens. So it's not very reliable security.
Worse, with these kinds of charges, you should normally assume that the P2P lending site hasn't even taken any kind of real effort to actually value the assets the business borrower owns, other than looking at a few financial numbers provided by the borrower! Because that's usually the case.
So you don't even really know with great confidence what assets the borrower has to begin with.
Trust me, I'm a company director!
Also, some other P2P lending sites, such as Rebuildingsociety*, have been known to call business loans secured if the directors have given a “personal guarantee” to lenders. They personally will try to pay off the debt if their business can't afford to do so.
But personal guarantees are far weaker protections for lenders than getting a legal charge on real assets on the lenders' behalf. There's usually no real guarantee that the director will have enough assets to repay the lenders anything at all.
What secured business lending are you looking for?
So what are you looking for? Really, properly secured business lending is when a charge is taken over specific assets that the business can't sell without your permission – or the P2P lending site's permission acting on your behalf.
But not a fixed-and-floating charge. A first charge is what you normally want. This is the same charge that your mortgage lender takes from you. If you are unable to repay your mortgage lender, it could force a sale of your property.
Your mortgage lender will take its cut before you can keep anything that's left. If anything is left. You get the same protection when you lend your money to a borrower with a first charge.
Instead of a first charge, a deed of trust usually does exactly the same thing. It's a different kind of legal contract but still provides the same protection to you. But it is more rarely used.
Sometimes you might be offered a second or third charge instead of a first charge. These can be fine if you're confident in the loan and the P2P site, but they are not as good as a first charge.
A charge lower than a first charge means that the borrower has other outstanding secured loans and your loan is lower in the pecking order.
So let's say your borrower has a property valued at £1 million and has borrowed £400,000 from NatWest with a first charge and then it borrows £400,000 from you with a second charge.
If that property has to be sold and can only be sold for £700,000, NatWest would get the first £400,000 of that, while you and the other lenders in the P2P loan will share £300,000. In other words, you'd get 75p in the pound.
When assets like yachts or luxury cars are used as security, you might ideally like to see that the yachts are taken into possession by the P2P lending site and stored securely with insurance – preferably at the cost of the borrower. The P2P site is then allowed to sell them if a borrower does not keep to the terms.
Sometimes, when the borrower is a business, the “asset” is invoices due to be paid to the business by its existing customers. In this case, you might want to see that the P2P lending site funnels the customers' payments through its own accounts before passing on anything that's left to the borrower.
Going beyond the basics
That's just the basics, more or less, of secured lending. There can be other things to look for as your confidence and skill grows in selecting loans or P2P lending accounts.
For example, you normally want to ensure that the property security has been properly valued by an independent surveyor.
Another example, you might prefer to lend against property that is not occupied by the owner. (Admittedly, very few P2P loans are secured against own homes.)
This is because, if you lend £50,000 to borrowers against their own £500,000 home, and the owner-borrowers live there with a young family, a judge is less likely to want to kick them out of their home in a hurry just so you and a few other lenders can get their 50 grand back.
So that's secured lending. Do check out Why Should I Do Unsecured Business Lending?