What Is An Asset-Based Loan And How Does It Work?
Asset-based lending refers to secured loans that use a company’s assets as collateral. A percentage of the asset’s worth is advanced to a business so that they might expand or overcome a financial bump. With the collateral in place the lender is assured the loan will be reimbursed regardless.
What Is An Asset-Based Loan?
Asset-based loan financing is when a business uses company assets as collateral in order to secure a loan from lenders.
These assets can take the form of inventory, equipment, property, or accounts receivable. An asset’s worth will determine how much can be borrowed. Additionally, it’ll determine the loan’s rate of interest.
It can be a smart way of securing working capital to help fund expansion for small to mid-sized enterprises.
How It Works
There are many reasons why businesses require an injection of funding over and above their profits. There might be a temporary cash-flow situation that needs resolving or perhaps a restaurant is looking to enlarge their kitchen space.
Asset-based loans (ABL) are a means of securing this cash boost by placing a business’ resources and future revenue up as a guarantee to lenders. By doing this, a lender is assured that the loan and its interest will be paid.
Asset-based lenders will typically release funds based on a percentage of these assets’ value. For eligible receivables this will usually be around 80%. For finished inventory, it might be as low as 50%.
If cash assets don’t suffice then the lender may consent to approving a loan against a business’s physical assets. Although, cash assets are preferred since they’re easier to liquidate should the borrower default.
Why Opt For It
It’s normal for any business to sometimes require a loan or line of credit.
When the need arises, a business owner might look to credit cards or look to increase an existing overdraft. Alternatively, an unsecured loan might be sought after. However, these can be difficult to obtain in the commercial world, especially for startups.
An asset-based loan is often the best way to source capital, but only if the company meets following criteria:
- Good financial statements
- Commonly sells inventory
- Customers have a proven history of paying their bills
Why are asset-based loans the most viable option under these set of conditions? First and foremost, it’s because lenders will view the borrower as a safe bet and therefore offer good terms and conditions.
Additionally, there are several other advantages to consider.
- The typical APR of an asset-based loan is between seven percent and 17 percent. This is generally lower than unsecured loans
- These loans are structured as revolving lines of credit
- As long as the lending criteria is met, such loans are generally hassle-free with little documentation needed
- They include hardly any covenants
Types Of Collateral Used In Asset-Based Lending
From a lender’s perspective, the assets used as collateral are ideally valuable. Physical assets should be easily sellable and cash assets should be easily retrievable.
Above all other considerations, a lender will assess if any given asset will maintain its worth for the duration of the loan’s lifespan.
To ascertain this, asset-based lenders will do its due diligence prior to agreeing to any loan. This will require researching a company’s financial status and the kinds of collateral that’s being offered up.
Lender’s main areas of interest will lie in the following assets:
- Accounts receivable: Often shortened to ‘AR’, these are the lifeblood of a business’s cash-flow. A company’s AR documents the money that the business is set to receive for its goods or services. It includes invoices due up to a three month period. Above all else, they’re the clearest indicator of a business’s income
- Equipment and machinery: Whether it’s a drop saw in a timber plant or a café’s ice cream maker, the only relevant factor is that it’s of high value and can be easily liquidated
- Inventory: Simply put, a business’s inventory is its stock. This can apply to either a finished product ready for sale or raw materials
- Real estate: This can pertain to any property owned by the business, including offices or retail space
How To Apply For Asset-Based Lending
Before applying for a loan, business owners must thoroughly check their financial stocks. This is used to best identify what assets might appeal to a lender. All bookkeeping and documentation should be brought up to date as well.
The following three steps won’t only increase a business’s chances of getting approved but will make the process relatively painless.
- Have all the paperwork in hand: This includes balance sheets, financials, sales, and any proof of ownership for machinery or equipment. A robust set of documentation will suggest to a lender that the business is in good shape and is being run by a organized individual
- In-depth asset analysis: After identifying the assets, it’s now time to get them in ship-shape and to properly evaluate their true worth. This can be as straightforward as installing a new part in an item of machinery that was previously faulty, making it as good as new. Additionally, an accounts receivable aging report is necessary
- Apply: Typically this will initially be done online, with the aforementioned documents submitted. It’s not uncommon for the lender to then request an on-site audit. A loan offer will likely follow based on their findings
Asset-based loans can be an invaluable source of capital for companies. They’re easier to obtain than unsecured loans. Moreover, these loans come with lower interest rates than most other funding options.