The significance of collateral
Yvonne Harvey, Contributor

Today we will consider the significance of collateral in accessing capital to establish a business then move on to explain the purposes of a feasibility study.

Last week, we looked at some of the ways in which businesses can raise venture capital. Included among these ways was the borrowing of money from financial institutions. In many cases, a financial institution will not grant a loan to an applicant unless the applicant is able to supply adequate collateral.

Collateral is anything of value that can be sold quickly and the money used to cover amounts that a loan recipient has defaulted on. A number of items can be used as collateral, including:

• House titles
• Land titles
• Motor vehicle titles
• Titles for the businesses
• Investment documents (such as share certificates and debenture certificates)
• Antique furniture
• The cash value of insurance policies
• Gold, silver and other valuable jewellery
• Rare and valuable works of art

The value of collateral

The value of collateral lies in the fact that:

1. It is something that can be sold so that the financial institution can recover the outstanding money on the loan. The collateral is signed over to the financial institution. This is done when the loan applicant signs a letter of hypothecation.

2. Collateral or guaranteed loans are cheaper, in terms of rates of interest, since there is less risk for the financial institution.

3. A collateral loan is also easier to obtain than a non-collateral loan.

Some loans may not require collateral. A guarantor may be required to sign on behalf of the borrower. This person signs with the intention that if the borrower defaults on the loan, he or she will have to repay what is owing. This is another form of secured loan.

A few institutions may grant unsecured loans. In these instances, neither collateral nor a guarantee is required.

The feasibility study

Let us first find out what is meant by the term feasibility study. This is a detailed investigation to determine whether a business idea or project is technically, financially and economically viable, and if it will be successful before committing large sums of money to it. It is a screening exercise and is often described as a likelihood study.

To some, the feasibility study is a way of determining if a business idea is capable of being achieved. The question is asked: can it work and produce the level of profit necessary?

Factors relating to a feasibility study

• It is done before the business plan and usually after a series of business ideas have been discussed.
• It includes cost-benefit analysis.
• It results in the development of a feasibility report.
• Small teams of experts from marketing, production, finance and development produce this estimate.
• Past information is used to produce trends.

Purpose of feasibility study

A feasibility study:

• Determines if a business opportunity is possible, practical and viable.
• Enables one to take a realistic look at both the positive and negative aspects of the business opportunity.
• Identifies the reasons not to proceed; therefore saving time, money and heartache later on.
• Ensures that the business venture chosen will generate adequate cash flow and profits, withstand risks, remain viable in the long run and meet the objectives of the founders.
• Helps to frame and flesh out or shape specific business alternatives so they can be studied in depth.
• Outlines and narrows down the business alternatives.
• Provides quality information for decision making.
• Helps to increase investment in the business.
• Provides documentation that the business venture was thoroughly investigated.
• Helps in securing funding from lending institutions and other sources.

Homework:

(a) What is collateral? (2 marks)

(b) List THREE items that can be used as collateral. (3 marks)

(c) Your friend has decided to apply for a loan to start a small business. Advise him or her of TWO advantages of seeking a collateral loan. (4 marks)

(d) Define feasibility study. (2 marks).

(e) List THREE factors relating to a feasibility study. (3 marks)

(f) Discuss THREE reasons why a firm might produce a feasibility study. (6 marks)

Total marks: 20

See you all next week. Keep safe.

It's the store's first anniversary and Spaces threw a celebratory party, recently. From left: Yaneek Page, Terise Kettle, Candice Stewart and Janelle Pantry, store owner, sport matching smiles. - Winston Sill/Freelance Photographer

Yvonne Harvey teaches at Glenmuir High School.