Unsecured credit means credit which, when unpaid, cannot be reclaimed through the seizure of an asset. This is important to note because unsecured credit facilities may be confused with secured credit. Though lenders have other methods to regain the value of the credit they offered (such as a court decree saying the lendee must repay the lendor), there is no asset promised by the receiver of the credit.
On a small scale, unsecured credit loans are more simple to acquire than secured credit. For example, credit cards are the easiest method of credit to acquire outside of the financing of “friends, family, and fools”.
On a large scale, an unsecured credit agreement is fairly difficult to acquire. The example of this would be mezzanine debt financing: mezzanine financing is virtually as difficult to acquire as venture capital. In this situation, companies generally use an unsecured credit facility when they can not receive secured credit. This situation occurs when the company can not meet the requirements or obligations of the secured credit lender or prefer to keep their assets free of obligation.
The business owner makes the final decision on whether secured or unsecured credit is the best decision. A general rule of thumb would be that if the company has more to lose by collateralizing an asset then not receiving the financing, unsecured credit may be their best option. consult a trained CFO to find the best option for your business.
For example, Karl is an entrepreneur who has started a company which manufactures precision electronics for the military. Because Karl makes each item to changing specifications, Karl must keep a lot of supplies on hand. He must have a strong base of credit to cope with his customer’s changing demands.
Karl has recently outgrown his current lines of credit. To make matters more complicated, he already promised almost all of his assets as collateral for other loans. With no option left, Karl must find an unsecured credit provider. He knows that credit cards will surely not be able to support his needs. He sees mezzanine debt financing as the only option.
After consulting with a trained CFO, Karl realizes that his company will actually lose profit by receiving the funding. The CFO clearly spelled this out in the financial analysis he provided. It seems the best option is for Karl to grow a little slower. Though he will have to deny some customers, it will ultimately result in a stronger business. Going forward, Karl’s company will be financed by free cash flow. Though Karl does not feel like as much of a “high roller”, he is happy that he made the prudent decision.