Asset-based lending, also called asset-based financing, is a type of financing that’s secured by collateral. Many businesses use loans from asset-based lending companies that are designed to work as revolving lines of credit. This lets organizations cover expenses or investments as needed by borrowing from their assets on an ongoing basis.
Keep reading for more information about asset-based lending, how it works, its benefits, and how it’s related to other types of lending.
Understanding Asset-Based Lending
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In asset-based lending, many types of assets or collateral can secure a loan. These include accounts receivable or the income a business gets from regular customers, the company’s inventory, marketable securities like stocks and bonds, and the property and equipment the business uses to operate. Some lenders will even accept intellectual property rights. For example, the producer of a movie could offer the finished film and the script as collateral.
Banks prefer more liquid collateral that can be converted to cash easily. That way, they can get their money back quickly by taking the collateral if the company defaults on its payments. For example, regular income from accounts receivable would be a more appealing form of collateral than the specialized equipment that a factory uses because selling that equipment could take months or even years. However, most financial institutions are willing to make collateral loans on property as well as more liquid assets. Since banks consider more liquid assets less risky, they often charge lower interest rates.
How Asset-Based Lending Works
Small and large businesses can qualify for an asset-based loan. These include retailers, wholesalers, distributors, and service providers. Asset-based lenders prefer a company with strong assets and a stable balance sheet, but organizations that are coping with financial challenges can still get asset-based loans if they have valuable collateral to offer. Many financial institutions won’t give companies that are struggling an unsecured loan. An asset-based loan is a good option to maintain cash flow and keep the business running normally during a downturn.
The size of the asset-based loan that a company can qualify for depends on the lender’s policies. In most situations, a business can borrow 75% to 80% of the value of its accounts receivable. If the collateral is an organization’s inventory, it can usually get equal to 50% of the inventory’s value. These percentages are loan-to-value ratios, the relationships between the values of collateral and the values of loans. For example, a borrower owns these assets:
- $105,000 in marketable securities.
- $120,000 in accounts receivable.
- $250,000 in machinery.
The marketable securities are the most liquid asset, so the lender could give 85% of their value, $89,250. Accounts receivable is also a liquid asset, so the lender might be willing to give a 70% loan, or $84,000. Machinery is the least liquid asset, but it’s the most valuable. The borrower could get a loan of 40% of its value, or $100,000. If the business only wants to use one asset as collateral, they should choose machinery.
Before a lender approves a loan, they will do research about the business’s financial status and credit history. They’ll also look at the company’s accounts and financial records.
The Cost of an Asset-Based Loan
Like other loans, you can expect to pay interest on an asset-based loan. The annual percentage rate (APR) is the amount of interest per year. For example, on a $100,000 loan with a 10% APR, you would pay about $10,000 per year in interest. The amount of interest due declines every year as the remaining balance on your loan gets smaller. Since asset-based loans are less risky than many other options, they often charge lower APRs.
The Benefits of an Asset-Based Loan
Many loans require a lot of documentation, but asset-based loans are easy to obtain as long as the company meets all of the required criteria. Investors can use short-term, asset-based hard money loans, also called bridge loans, to finance renovations or property acquisitions. They can also help a business get through tough times. Hard money loans usually last for 1 – 3 years, so your business can get the financial cushion it needs.
These loans are completely asset-based, so there’s no need to meet income requirements. Many people and businesses with low credit scores can qualify, and you can spend the money from the loan however you prefer. Lenders are also willing to approve larger loans when they know they can recover any losses by liquidating the borrower’s collateral.
Lenders usually require consistent weekly or monthly reporting from borrowers about their cash flow and accounting practices. This reporting takes some added effort from businesses, but it can help them develop better cash management and financial reporting practices. Similarly, lenders may require regular field exams, audits, or appraisals of equipment to make sure that the collateral retains its value. These inspections can help businesses discover and repair problems before they become severe and costly.
How Asset-Based Lending Is Related to Other Types of Lending
Before you choose a loan, it’s important to know what’s available. Here are some of the most common types of loans for businesses. These loan types can be asset-based or non-asset-based:
- Term loans: The borrower gets a fixed amount of money upfront, and they agree to pay it back on a specific schedule. Asset-based mortgage lenders often offer term loans for real estate investments.
- Revolving business lines of credit: These accounts are similar to credit cards, and they can help companies with sudden expenses or short-term cash flow issues. The business can use as much of its credit limit as needed, and they can keep their limit high and their interest charges low by paying balances as soon as possible.
- Personal loans: Business owners that have strong personal credit and weaker business credit can apply for a personal loan, but they risk their own credit if the business fails, and they may have to submit their own assets, like their home, as collateral.
For more information about asset-based lending and how it can help your business, contact Titan Funding.