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Business banking: What is an asset-based lending?
Asset-based lending is a great way to finance business operations, as it is based on quickly-moving assets - thereby allowing beneficiary businesses to borrow funds on an ongoing basis. Such loans work in pretty straightforward manner, but might not be the best option for all types of companies. Also, if this type of business financing has many advantages, it also has its disadvantages.
Asset-based lending explained
Asset-based lending is a business financing facility using quickly-moving assets as collateral. This makes it a great tool for many businesses, but some may find it difficult to have access to it.
Principles of asset-based lending
Asset-based loans are secured by company assets used as collateral. These assets are usually quickly-moving assets such as inventory and accounts receivables like outstanding invoices. In some cases, other assets like equipment or real estate can also be used. The borrowing base represents a percentage of the value of these assets which have been pledged, typically, from 75% to 85% of the value of pledged accounts receivable, or 50% or less of equipment value. After a due diligence process, during which any encumbrances to the collateral is weighed, lenders determine this percentage and the APR of the facility, which may be as high as 17%. Contrary to a factoring arrangement, receivables are never sold to the financial institution, and businesses remain in charge of debt collection.
Theoretically, any business can get an asset-based loan, as long as the company has quality reporting systems, steady inventory and a track-record of payments made according to terms by customers. This financial facility is very often resorted to by fast-growing companies with an already existing solid customer base and steady flow of revenue. Distributors, manufacturers, and service companies with a leveraged balance sheet and special seasonal needs are usual customers for this kind of business finance. Small companies may find it hard to find a lender for this type of product as most asset-based lending facilities have a pretty large amount of minimum utilisation requirements, as it costs the lender the same to monitor a small and a large loan.
Pros and cons of asset-based lending
Asset-based lending facilities have their advantages and disadvantages.
Advantages of this type of credit facility
These business finance facilities are very appreciated because:
- they provide quick and easy funds to restore working capital during temporary times of stress, which is especially appreciated by fast-growing, undercapitalised businesses,
- they can represent revolving lines of credit for ongoing finance to cover expenses or investments whenever they are needed when sales remain steady and regular.
For all these reasons, this type of business finance is often resorted to when financing acquisitions.
Disadvantages of asset-based lending include:
- the fact that it might be difficult for some businesses to access this kind of facility, as sales to individuals, small businesses or late-paying clients may not be deemed eligible;
- the fact that these loans cost more than other, as many fees can be added to already pretty high APR;
- the fact that many lenders require to directly receive the payments used as collateral, bypassing the company and gaining control of its cash flow.