Small Business

"Pawn" is No Longer a Dirty Word

The oldest form of lending is making a comeback as business owners turn to creative financing solutions

Written by Steven Uster

The oldest and simplest form of lending is the collateral or “pawn” loan. For hundreds of years, people have used their jewelry, gold or other personal assets as collateral for loans. It was simple. Borrowers had assets of value, and lenders had cash. The borrowers would trade their assets for the lender’s cash until the borrower no longer required the cash, at which point they would trade back. Queen Isabella of Spain even pawned her crown jewels to finance Christopher Columbus’ voyages to the New World.

But at some point, this basic form of lending developed a negative reputation. It took on the associations of seedy, neon-laced shops in the wrong part of town reserved for those who were down and out and looking for a way to make last month’s overdue rent payment.

Recently, though, pawning has seen a resurgence as a mainstream financing source for small businesses. I can hear you snickering now as you think to yourself, “Small business owners pawning assets for a quick loan. Really?”

Yes, really.

After the 2008-09 financial crisis, when banks slashed their lending to small businesses around the world, a new breed of lender sought to fill the void. By acknowledging that wealth doesn’t always translate into liquidity, these pioneers created a new category—first in the U.K., then in the U.S. and now in Canada—called personal asset lending. These lenders are taking the concept of the pawn loan into the internet era, and this is catching on with business owners as a viable funding source.

In fact, it’s catching on so much so that this category is attracting substantial interest from large venture capital firms. For example, Borro—which was founded in the U.K. and now also operates in the U.S., although not in Canada—raised over US$40 million in VC funding and another US$50 million in debt to fund loans. It also added Capital One co-founder Nigel Morris as chairman of its board. Another player, Pawngo, is funded by Lightbank Ventures, the VC firm formed by the founders of Groupon, and operates only in the U.S.

My own company, Zillidy, launched in Canada to fill the void in the market here. And yes, I can understand why you might therefore be sceptical about reading what I have to say on this subject. But even though my firm offers this sort of financing, I don’t think it’s by any means right for everyone. So the following primer on personal asset loans not only explains when it makes sense to consider this financing option but also when it doesn’t make sense.

How does a personal asset loan work?

There is no more looking over your shoulder as you clutch your Rolex watch in your pocket, step over a drunken guy sleeping on the stoop and enter a store with bars on the windows and flashing neon lights.

There is no more feeling exploited as you agree to a $500 loan for your watch that you know is worth $10,000, then pay exorbitant interest rates and fees for the privilege of potentially losing your watch if you’re a day late or a dollar short.

Nowadays, personal asset lenders are more like private banks that recognize that a client may at any given moment have his or her wealth tied up in jewelry, diamonds, watches or bullion—but not in cash.

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This type of lender is geared to small business owners who can’t wait for a bank to approve a loan, know they will never get that approval or just don’t want to bother dealing with banks and need short-term capital. The entire loan process can be done online, by first describing the asset through the website and then using a pre-paid courier to ship the asset for storage throughout the loan period. Or the loan can be consummated in the lender’s office.

The lender automatically deposits the loan proceeds into the borrower’s bank account, with the interest payments automatically deducted each month. The entire transaction can be done in as little as 24 hours and doesn’t require credit checks, background checks or financial diligence. The amount of the loan is based on the appraised value of the asset used as collateral, not on the creditworthiness of the individual borrower or the business. And no personal guarantees are required.

Personal asset lenders generate their revenue solely from charging interest on the loans. So, like a bank, they have an incentive to lend as much as safely possible, relative to the asset value. And they’ll restructure loans in default or manage the sale process on behalf of the client in order to recover the amount owed. This is unlike pawn shops, which have an incentive for you to default on your loan, because then they can claim ownership of your asset and make a windfall profit by selling it.

Different lenders lend against different types of assets. Count on being able to use precious metals, high-end jewelry, diamonds, luxury watches, fine art, high-end automobiles or even fine wine as collateral. Remember, the lender will hold the asset in a secure facility (and fully insure it while it’s in their possession) while the loan is outstanding—so you can’t use machinery, equipment or vehicles that your business relies on to generate revenue as collateral.

What are the pros of a personal asset loan?

For business owners, there are several advantages:

  1. The lender doesn’t register security against the borrower: This type of loan won’t interfere with a business owner’s ability to get alternative funding. It is effectively off balance sheet financing—although you need to ensure that no other lender has claim to the same asset.
  2. Credit scores aren’t important: There are no credit checks to determine creditworthiness or loan amounts, and loans aren’t reported to credit bureaus or collections agencies
  3. Diligence is limited to the appraisal of the asset used as collateral: It isn’t necessary to review the bank or financial statements of either the business owner or the company.
  4. The entire process can be completed within hours: This can mean the difference between capitalizing on an immediate business opportunity and missing out.
  5. The same asset can be used over and over again: It’s as if your Rolex watch just turned into an ATM on your wrist, available to be tapped into whenever the need arises.

OK, but what about the cons?

Personal asset collateral loans aren’t for everyone or for every situation. Here are the potential downsides you should consider:

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  1. There’s a trade-off between cost and flexibility: Because these loans are highly flexible in terms of the repayment and loan term and don’t require personal or corporate guarantees, the interest rates are substantially higher than those for traditional bank loans. They’re more in line with the rates for credit cards or accounts-receivable factoring.
  2. Like any asset-based loan or mortgage, the lender has recourse: If you default, the lender won’t repossess your car or equipment or foreclose on your house. But they will liquidate the personal asset held as collateral. So if you think there’s a chance that you’ll default and you don’t want to lose that heirloom piece of jewelry or fancy Breitling watch, think twice before considering a personal asset loan.
  3. The lender physically holds your asset: If you’re like me and feel naked if you leave the house without a watch on your wrist, consider whether you can temporarily give up an asset before pursuing this financing option.

Who should consider this option

To be clear, I’m not advocating that we return to the days of Queen Isabella and Christopher Columbus, when it was commonplace to use one’s valuable personal assets as collateral for loans on a regular basis. And personal asset loans are not a good idea as a permanent capital solution for growing, stable companies, nor as a way to replace traditional financing.

But they are an option worth considering in some specific business situations, such as: during a slow or peak period for a seasonal business; to capitalize on an immediate profitable opportunity; to bridge the gap while waiting for a large receivable to be paid or a major contract to be signed. As well, loans of this type can be a valuable tool for specific types of people, such as an entrepreneur who is constantly seeing new investment opportunities or a business owner who runs a successful business, yet is still considered self-employed without proof of income by their bank.

Steven Uster is the founder of Zillidy, an alternative finance company that provides personal asset loans secured using precious metals, diamonds, jewelry, watches and other luxury assets as collateral. He is also the founder of Eldridge Capital, which provides accounts receivable financing for Canadian companies.

More columns by Steven Uster

Originally appeared on PROFITguide.com
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