Numerous companies have to cope with financial struggles after the recent economic crisis that hit many countries globally. The vulnerability of most businesses due to credit default is high. It is because the volatility of the market leads to difficulty in accessing unsecured loans. Many financial institutions are not willing to take the risk of lending their money. As a result, many companies willfully use their assets as collateral to banks and financing firms, which is known as asset-based lending.
Thus, Asset-Based Loan financing will ask the borrowing company to use their assets as collateral to get the desired loan. Hence, a company will likely take the decision when it needs to expand. It is a way to survive the economic crisis and grow. In asset-based loans, the security of the lender’s interest is through the assets of the borrower. It collates by how large of a loan a company can access.
Indeed, all the small and large sized companies can qualify for an Asset-Based Loan. You can be wholesalers, retailers, distributors, and even service providers. However, many of the asset-based lenders will only approve credit to a company with a stable balances sheet with substantial assets.
What Is Asset-Based Lending?
Asset-based lending is the lending of money under an agreement that is secured by collateral. The collateral to be may be in the form of inventory, accounts receivable, equipment, or other property under the ownership of the borrower.
Why access Asset-Based Lending?
- Growth –To support the growth ambitions of your business by maximizing the cash available to help you secure new contracts, recruit, or investments.
- Refinance –alternative funding that releases cash from the balance sheet to date and offering more significant working capital.
- Restructure – It offers the flexibility to restructuring deals
- Mergers and acquisitions –Asset-based lending is biased to support merging and acquisitions of companies.
- Management buyouts –Allows the management to acquire their business while providing on-going working capital support.
What Are the Benefits?
- It is easy and quick to get approval from the lender. Hence, less hassle and does not require much documentation for as long as the company meets the lending criteria.
- It can help support your business towards financial stability. These loans can absorb dents and stress in a time of economic challenges. The company can quickly restore it to a stable financial state.
- Realistically, it is easier to qualify for an Asset-Based Loan compared to other lines of credit. It is because it only involves a few processes. However, the collateral of the company would still be significant in the approval process.
- There are restrictions, but these are flexible when it comes to how the company will utilize the funds.
- Asset-based loan financing can keep your borrowing options open and stay debt free.
How Asset-Based Lending Works
To take out a loan is essential for many businesses to meet the cycle of cash flow demands. For example, a line of credit will cover the payroll expenses even if there’s a brief delay in payments it expects to receive from the customers.
If the company looking for the loan cannot show cash assets to cover a loan, the lender may offer to approve the loan if the physical assets of the business will stand as the collateral.
Hence, the terms and conditions will depend on the type and value of the assets that the borrower will show as collateral. Lenders prefer highly liquid guarantee that can be converted to cash if the credit goes default. Moreover, there is a higher risk if the loan is in the form of physical assets.
Example:
A company is looking for a $200,000 loan to expand business operations. If the company commits the highly liquid marketable securities on its balance sheet as collateral, the lender can grant credit at around 85% of the face value of the securities. Meaning, if the company’s securities are at the amount of $200,000, the lender will be willing to loan $170,000. If the company opts to make less liquid assets, like real estate or equipment, the lender may offer 50% of its required financing.
The interest rates of asset-based credit are lower than rates on unsecured loans because the lender can pull through its losses if the credit goes default. However, the charging of interest rates will vary depending on the credit history of the applicant, cash flow, and track record in doing the business.
What’s the downside of Asset-Based finance?
The chances of getting the approval of a credit line are only as good as the quality of the receivables. Commercial lenders will sort through your customers to identify the ones who can pay in less than 60 days. However, in Asset-based lending, the sales to individuals or small businesses may not get the considerations as “eligible receivables.”
- Asset-based loans cost more than traditional loans.
- Interest rates will vary wherein banks will sometimes include additional “audit” and due diligence fees to the overall cost of an asset-based loan.
- There are large banks that will require your guarantee
- There are cases that asset-based lenders will require that your customers will send their payments directly to the finance company. When this happens, a third party will gain control of your company’s cash flow.