Asset-Based Lending: Financial Tool That Can Keep a Business Running

Melissa Santos

By Melissa Santos, Principal, Troy Business Group

In today’s highly competitive, business-centric global environment, American businesses are turning to alternative mortgage brokers and private financing firms to acquire financing based on their balance sheet assets.

Why? Because conventional banks, credit unions and government-owned and regulated financial institutions have failed to offer them the flexibility they seek in a transaction. The bureaucratic banking structure, long processing time, lengthy documentation process and credit limits, among other requirements, have made them a secondary option for a number of borrowers.

Under these conditions, asset-based lending has emerged as a financial tool for small and midsized businesses and for entrepreneurs who are looking to maintain or grow their businesses.

Lending Based on Collateral

In simplest terms, asset-based lending is a form of commercial lending where a fixed asset is kept as security, generally known as a collateral. Money or finances can be acquired instantly on the basis of highly liquid assets such as accounts receivables, inventory, machinery, equipment and other balance sheet assets, to further improve your cash flow position and to accomplish both your short-term and long-term goals. However, in the case of nonpayment, the financing institution or company reserves the right to liquidate the assets for recovering its cash.

It’s important for businesses of all sizes to keep a certain level of cash reserve in the bank to generate quick working capital or to meet specific short-term cash requirements. Once the capital is acquired by pledging an asset, you will be able to improve your cash flow and fund day-to-day operating expenses and other certain short-range cash needs. This indicates that asset-based lending can come to your aid and save your business from going under a stringent financial phase.

The most common types of asset-based lending include:

• Accounts Receivable Financing: This is a subset of the asset-based lending arrangement that uses the receivables, such as unsettled business bills, invoices or money owed by business customers, as collateral to receive the financing.
• Traditional Factoring: Invoice factoring, as it is mostly referred to, is the type of asset-based lending where outstanding invoices from business customers are sold to any third party (usually a private financing firm or factor) to get access to fast money for meeting multiple short-term financing needs
• Inventory Financing: In simplest terms, inventory financing is the loan acquired using inventory as collateral. The business would be awarded a line of credit based off the appraised value of their inventory.

Asset-based lending can help SMBs and entrepreneurs meet seasonal and time-sensitive capital requirements and accomplish short-term and long-term financing goals and objectives with loan flexibility.

Banks are looking to build a different loan portfolio and consider an applicant’s credit score, history, proof of asset’s worth and have layers of documentation requirements. The market share of traditional financing institutions has dropped over the years due in part to their policies and documentation requirements.

As with any financial tool, there are pros and cons. To be eligible, the company has to be in good financial standing, have an accounts-receivable portfolio the lender can get behind and have assets in good standing, too. Asset-based lenders focus on collateral and their own ability to profitably liquidate that collateral if the company defaults on the loan. Critics contend asset-based lending can force borrowers to default too quickly if the borrower’s financial picture changes. Such loans also require a great deal of collateral monitoring, so borrowers may need to adjust financial reporting practices to use such a loan.

Repayment terms vary but are generally based on the annual percentage rate (APR), the yearly cost of borrowing money that includes interest and fees assessed, sometimes with an additional fee from the lender. It can be a wide range.

Cash-Flow Incentive

Why has asset-based lending been gaining popularity in recent years? Primarily because it can …