To meet certain cash-flow and inventory needs, businesses take out loans. Learn here what is asset-based lending and to get an asset-backed loan.
Your business is growing fast. Too fast, in fact–you don’t have the capital to keep up with it.
And while you don’t have cash flow on hand, you do have assets.
So you might be wondering to yourself, “What is asset-based lending?” And more importantly, how can it help your business? Keep reading for a complete breakdown of everything you need to know on the subject.
What Is Asset Based Lending?
Asset-based lending is pretty much exactly what the name implies–loans based on assets, typically inventory, accounts receivable, equipment, or other balance sheet assets which are used as collateral.
It’s sometimes called commercial finance or asset-based financing. With that in mind, let’s take a closer look at how it works.
How Does It Work?
As a rule, businesses take out loans when they need to ensure cash flow to continue operations, like meeting payroll.
That’s all fine and good, as long as the business can show that it’s able to pay for the cost of the loan through cash flow. If the business can’t prove that to a lender, they’re in a bit of a tight spot.
This is where asset-based lending can help. Instead of looking at cash flow, the lender will instead look at the value of the entity’s assets.
When this happens, the loan is granted solely on the value of the assets the business pledged as collateral. This means that if you fail to repay your loan, the lender will claim those assets to make up the difference.
What Assets Can Be Used as Collateral
As a rule, lenders typically prefer highly liquid assets to be put up as collateral. This makes it easy for them to convert the assets to cash if the borrower (you) defaults on payments.
Typically, lenders like to take accounts receivable as the primary collateral. They will, however, accept things like liquid inventory, equipment, and other similar assets.
The more liquid the asset, the higher the loan-to-value ratio. Keep in mind also that loans granted in this type of financing are never equal to the full value of the assets pledged as collateral.
Who Uses Asset Based Financing?
Typically, lending of this kind is advisable when a company needs working capital in order to maintain business as usual. Companies that request this type of lending usually have cash flow problems, which is why they cannot qualify for other types of loans.
That said, these cash flow issues are often the result of growing pains–the business is growing so fast that the actual company doesn’t have the overhead to keep pace with it.
Benefits of Asset Based Lending
One of the biggest benefits of asset-based financing for companies is the financial stability they provide. They also provide it much faster than conventional loans. The approval process for asset-based loans is typically faster than conventional financing.
They’re also easier to get than other types of loans. After all, you don’t need the cash flow, you just need the assets, and many businesses have one but not the other.
In addition, asset-based loans often provide greater flexibility in terms of how your company is allowed to spend the money.
Is an Asset-Based Loan Right for You?
With that in mind, is asset-based financing right for your company?
Well, that depends on your company, what your current financial situation looks like, and how comfortable you are with the possibility of using your accounts receivable or inventory as collateral.
Calculating any business loan is a careful balancing game.
Figuring out whether this type of loan will work for your business is a calculation of the cost of the loan relative to your assets, how much of a loan you can secure, and how much you can afford to pay off at a later date.
So, let’s take a closer look at the factors determining the cost of your loan and how much of a loan you can qualify for.
Cost of Asset Based Lending
The cost of an asset-based loan depends on the value of the collateral used, the amount of the loan given, and the risk associated with the loan.
Let’s say a company wants to secure $100,000 in loans. If that company pledges their liquid marketable securities as collateral, the lender may grant up to 85% of the face value of the assets.
So, if the company’s collateral assets are valued at $100,000, then the loan would be worth $85,000.
If the company pledges less of their liquid assets, they’ll get a smaller percentage of the needed financing.
You also need to factor in interest rates. Typically, interest for asset based loans is lower than conventional loans. This is because if the borrower defaults, the lender can seize assets to recoup their money.
As such, the interest is based on the size of the loan (which is in turn based on the value of the pledged assets). Annual percentage rates typically run between 7% and 17%, depending on the size of the loan in question.
What Determines How Much of a Loan You Get?
In short, the answer to this question is your assets.
We said earlier that loans are secured based on the value of your assets, and that they typically don’t match the full value of your collateral assets (this acts as a built-in cushion for the lender to recoup lost interest).
As such, the fewer liquid assets you pledge, the smaller the loan you’ll receive. It’s pretty much that simple.
Helping Your Business Thrive with Asset Lending
Now that you know the answer to the question, “What is asset based lending?” do you think it’s the right choice for your business?
If so, we’re here to help.
If you’re ready to apply, don’t wait. Your business is growing, and your customers won’t wait forever.