Creative Collateral

On the Money
From the June 2006 print edition

Sometimes, the word “collateral” may be uttered so many times that the very sound of those syllables causes gastric distress. Obvious forms of collateral include houses, cars, stocks, bonds, and cash—all things that are readily convertible into cash to repay the loan. Some of those assets are “hard,” such as houses and automobiles; others are “paper,” such as the stocks and bonds. However, there are other forms of collateral assets that are sometimes overlooked and can assist the new business in obtaining operating funds.

An asset is defined to be anything that has commercial or exchange value that is owned by a business, institution or individual. In addition to intrinsic or “hard” value, anything that has revenue or a potential future earnings stream can be used as collateral. This includes contracts for purchase or purchase orders, which are “collateralized” by the promise of future payment by your customer. Another form of collateral is loans you have made to other people, either simple accounts receivable or formalized promissory notes. It is possible to pledge the loans you hold as collateral for another loan to yourself.           Federally and state-chartered banks are constrained by regulations that strictly define collateral acceptance. Generally, the riskier the collateral, and the more difficult it is to liquidate, and so the more expensive the loan.

So what are some other “nontraditional” forms of collateral that are more likely to pass muster? One is “future earning power.” Basic to a lender’s willingness to make a loan is an ssessment of the future earning power of the rganization or individual. This is the principle behind all manner of educational loans; that is, with more education and training, the earning power of the borrower will be enhanced.

In the “very imaginative” category, other items

that have been used as collateral include: watches, jewelry, interests in box seats at a sports arena, golf club memberships, lawn mowers, suits of armor, opera tickets, antique furniture, art collections, vinyl record collections, insurance policies, medical instruments, lottery tickets, wine collections, tires, and even specialized pumpkin seeds.

Both lenders and borrowers are always searching for more creative and nontraditional ways to facilitate cash flow. This means an increased willingness to look at nontraditional collateral and open-minded borrowers regarding what they may be willing to pledge.

© 2006 by Risk Management Association.