Lenders require a deposit, also known as an equity injection, on a business loan between 10% and 35%, depending on the type of business loan. This is a way to recover some of the losses if the borrower defaults on the business loan. Loan deposits are standard procedure when taking either large or small amounts of financing and are often a typical policy for most lenders.
Alternative lenders and traditional banks normally require between 10% and 15% of the loan amount as a deposit. This includes SBA loans. The actual amount will be based on your credit history, finances, the use of the loan, the value of the collateral you offer, and your time in business. These factors apply for standard small business loans like working capital and equipment financing.
Commercial real estate business loans may require up to 35% of the loan price and the property as collateral, as the investment is riskier than other uses for financing.
On rare occasions where the business has an existing relationship with the lender and substantial cash flows, the amount could be around 5% or potentially waived. This is called a no-deposit-down business loan, which is like an unsecured business loan. The option is rare and normally only happens when the borrower has built-in trust with the lender from previous loans. Another common feature of this type of financing is that the payback period is typically shorter to reduce the lender’s risk.
Deposits Are About Reducing the Lender’s Risk
Deposits are about reducing lender risk by:
- Showing you’re committed to your business and are more likely to pay the loan back.
- Reducing the loan-to-value ratio which helps to make the deal more secure.
- Having a non-depreciating asset as collateral, unlike a vehicle which can lose value.
- Discouraging a business owner from borrowing more than they need, as the deposit increases with the total loan amount.
- Mitigating costs in the case of default.
It may seem counterintuitive to give money to the lender when you’re there to borrow money, but the amount you put down can get you better loan terms.
Larger Deposits Can Get You Better Business Loan Terms
The larger the deposit you make, the less risk there is for the lender and the more you show you have “skin in the game.” When you put more money into the deposit, you may be able to negotiate a lower interest rate.
Interest rates are how the lender makes their money. If you’re a higher-risk borrower, they’ll charge a higher interest rate because there is more of a risk you could default. By putting a larger deposit down, you reduce your risk. The payback period can also be negotiated.
By reducing the time you have to pay the loan back, you can clear the debt from your business credit reports earlier (if reported) and potentially help your business credit score. You can also use curtailments or prepayments to accomplish this.
Note: When you make early payments and clear the business debt sooner than expected, this can impact the lender’s profits. This is why they may charge you prepayment penalties. However, by putting a larger deposit down, you have room to negotiate that penalty out.
Pro-tip: National Funding doesn’t require down payments and doesn’t have prepayment penalties for paying off your financing early. In fact, you can take advantage of major savings with our early payoff discounts1 Fill out our application form to explore your options and learn more about our discounts today.
What Happens If You Don’t Make a Deposit
If you don’t make the deposit on the business loan or cannot raise enough money, you’re likely going to get declined. You could make a personal guarantee, which means the lender can seize personal assets to help offset their risk, or you could try to put more collateral down, but many lenders simply require deposits. That does not mean you cannot get financing.
If you cannot get approved for a business loan because you do not have the money for a deposit, you can try:
- Invoice factoring where you sell invoices to a factoring company, which is a company that buys your invoices for a portion of what you are owed and collects the full amount from your customers.
- Partnering with equity investors with a potential buyback where investors give you the money you need in exchange for partial ownership or a stake in your business. By having a buyback for a fee, you can retake control of your company, and the fee becomes profit for the investor.
- Financing from your personal assets like your 401(K) or a home equity line of credit (HELOC) or selling off assets like bonds and stocks. When you do this, you have to feel confident the business will succeed as you won’t have a safety net to fall back on.
Deposits are required on large and small business loans because the lender wants to reduce their risk, and it is likely a company policy to collect it. If you cannot raise the funds for the deposit, you’ll need to find an alternative form of financing or apply for a smaller business loan. When you can make the deposit or have the ability to put a larger amount down, you can negotiate better terms including lower interest rates, reduced penalties, and shorter payback periods.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
