Asset-based lending has been around since the origin of the loan industry. In the beginning, asset-based loans were as simple as a cash advance based on the worth of a company's assets. For example, if a business's assets were worth a total of $1,000, lenders would be willing to loan up to that amount with interest. Whether businesses were offered more or less was based on various factors, as it is today.
Asset-based loans have their own benefits and drawbacks, like any other form of financing. For some businesses, asset-based loans may be the right option, while there may be better alternatives for others. (See what options are available for your small business here.) Determining whether your business should consider an asset-based loan is a decision that requires serious reflection. Knowing how asset-based loans work and the common reasons businesses get them can help you determine whether one is right for your company.
How Do Asset-based Loans Work?
In the simplest terms, asset-based loans are financing that is lent to you using your company's assets as collateral. Your loan is extended with the understanding that your company's assets will be given to the lender if your company fails to repay the loan. Asset-based loan providers allow companies with credit difficulties or other cash flow problems to secure financing based on their assets. These assets can include inventory and accounts receivables.
Lenders consider several factors when deciding how much to lend a business. Depending on certain factors, lenders may not be willing to lend a company the entire worth of its assets. Instead, lenders sometimes determine that it is in their best interest to lend only a percentage of the value of your company's assets. There are several reasons why lenders might decide this. Many factors influence a particular lender's advance rate and the amount of actual cash it lends.
Generally, the more liquid a company's assets are, the more likely lenders are to lend more money. Asset-based loans take into account how easy or difficult it would be for the lender to seize assets in case of delinquency. If a company's main asset is its inventory, it will usually receive a smaller advance than a company whose assets are largely accounts receivable. Accounts receivables are closer to cash than inventory. This means they are more likely to resolve unpaid debts than inventory. That is an important factor for lenders when considering the terms of their loans.
Benefits and Drawbacks of Asset-based Loans
There are both benefits and drawbacks to asset-based loans. Some of these pros and cons may be more or less important to different business owners.
One advantage of getting an asset-based loan is that the loan's credit requirements are much more flexible. Lenders offer this added flexibility because you agree to use your assets to guarantee you will repay your loan.
Lenders offering asset-based loans are often willing to overlook past credit history. Many are also willing to give less weight to underperforming or unprofitable businesses, even ones with credit issues. As long as these businesses have a strong asset pool, lenders are willing to allow a lot of wiggle room. Businesses that are going through a bit of a rough patch can take advantage of asset-based loans. Asset-based loans are one way these companies can secure financing when their credit needs improvement.
Asset-based loans can have a side benefit, too. Since lenders tend to require more frequent reporting with consistent, accurate details, businesses tend to build even better financial management practices to provide this reporting.
Unfortunately, asset-based loans are not without their drawbacks. Asset-based loans can be useful for companies that need more financing, but there are some potential dangers. Lenders are always looking to make better customer experiences, but asset-based loans still tend to be time-consuming. Businesses have to make regular check-ins, often monthly or even weekly. This takes up company time and adds to the demands on your finance department.
The time commitment required is enough to turn some business away from the idea of asset-based financing. When considering an asset-based loan, make sure your business can set aside the time and effort necessary for the required reporting.
Some lenders may also require supplementary monitoring. This additional monitoring is designed to let the lender see that collateral values are maintained throughout the loan's lifetime. Lenders often require additional audits, field exams, and appraisal updates to keep the loan up-to-date.
What Kinds of Assets Can Companies Use for Loans?
Most lenders who offer asset-based financing design their loans to take an advance on your company's accounts receivable. Accounts receivable are a very liquid form of asset, and lenders prefer it above practically all else. This does not mean that lenders will not aggressively pursue other forms of assets; it just means that your business is likely to get better loan terms with more liquid assets. Lenders still offer advances on inventory in many asset-based loans. Some asset-based lenders focus on machinery, equipment, and real estate lending, too. Lenders try to be as flexible as possible in creating asset-based financing options.
Some lenders are increasingly becoming focused on one type of asset. Lenders tend to become experienced in a particular field or industry and direct their resources toward those. These lenders aim for a specific type of asset, making them more willing to lend to companies that have them.
Sometimes, specialized lenders focus on assets that the majority of their peers ignore. For example, intellectual property is often a specialized financing situation. Lenders are more likely to offer financing based on intellectual property from established brands since this allows them to easily find value using market research.
What Are Typical Loan Terms?
Asset-based loans typically last for two to three years. Most asset-based lenders want to be transitional credit providers of sorts, helping businesses on to the next step in their financial goals. Asset-based lenders usually lend to companies that are going through transitory periods and require extra financing to ease the process. This means that loans tend to be short-term. Capital-intensive businesses are one exception to this general rule, as they often use long-term, asset-based loans.
Are Asset-based Loans Right for My Business?
Answering this question is complex and always involves careful reflection on the part of business owners. Small and midsize businesses experiencing periods of growth or transition can benefit from asset-based financing.
Companies with assets on their balance sheets like accounts receivables, fixed assets, and inventory can get asset-based loans with relative ease. Businesses that use recurring revenue models, have little or no assets on their balance sheets, or primarily do cash transactions are not good candidates for asset-based financing.
Businesses that are capital-intensive are good candidates for asset-based financing. If you are a manufacturer or distributor, you will likely have an easy time finding an asset-based loan. The stronger your asset pool is, the more likely you will be offered a loan.
Additionally, the better your asset pool, the better your loan terms will be. Most industrial businesses are good candidates for asset-based financing, as well as retail, staffing, apparel, and business service companies. Businesses that have an intensely seasonal industry often do well with asset-based financing, too.
Getting a loan for your business can be a complex and time-consuming undertaking, but we hope this information on asset-based loans has been a helpful resource. Keep reading here for more information on other types of loans, or check out your options immediately with our free application kit.