An asset-based loan (also sometimes called “asset-based financing” or “commercial finance”) is a type of business financing secured by an asset (or multiple assets) of the company. Often, these loans are structured to function like revolving lines of credit, allowing the company to borrow from its asset(s) as needed on an ongoing basis to cover investments or expenses. Often, the assets used in asset-based lending are accounts receivable, equipment, real estate and/or inventory.
Who Uses Asset-Based Lending?
Commonly, companies that do not have the credit rating or necessary cash flow to obtain traditional methods of financing will opt for an asset-based loan. In most scenarios asset-based loans are used to help manage cash flow issues following a period of rapid growth. An asset based loan can temper this quick growth and position the company for future success.
Companies who are small to mid-sized, are stable, and have assets that can be financed (that are not collateralized to another lender) usually qualify for asset-based lending. Additionally, the company must not have any serious outstanding tax, legal, or accounting issues.
How Does Asset Based Lending Work?
First, the lender determines the borrowing base, or the percentage of the value of the asset to be used as collateral. The borrowing base is usually 75% – 85% of the value of the accounts receivable and 50% or less of the value of inventory and equipment. Since the value of the assets will fluctuate over time (especially in the case of accounts receivable), asset-based lenders will evaluate the value of the collateral regularly, and will adjust the borrowing base as appropriate.
The cost of an asset-based loan depends on the size of the loan, the type of collateral, and the overall risk. The APR (annual percentage rate) usually varies from 7% to 17% based on these factors. Rather than relying on the company’s credit rating, the lender will gauge risk based on the quality of the collateral.
How is Factoring Different from Asset-Based Lending?
Often mistaken for asset-based lending, factoring is different from asset-based lending in an important way. Factoring is a transaction where a company sells its accounts receivable to a third party (the factor) at a discount to obtain cash. This is different than an asset-based loan, which simply uses its assets as collateral for a loan.