Cash flow refers to the movement of cash both in and out of a company. It just so happens to be the lifeblood of all businesses as well. Cash flow makes it possible for companies to meet their financial obligations and stay in business.
But sometimes, due to unforeseen circumstances, a company’s cash flow could come to a halt, causing disruptions to your business operations. Thankfully, there is a solution, that being asset-based lending.
Asset-based lending could potentially infuse much-needed liquidity when your company needs it the most. Keep reading to learn all about asset-based lending and what it can do for you.
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What is asset-based lending?
Asset-based lending is a type of secured financing that businesses can rely on when business owners are facing cash flow disruptions. The security or the collateral that backs the loan could be in the form of equipment, stock, inventory, account receivables, real estate or a number of other assets owned by the business.
This type of business financing is ideal for companies that own assets yet need funds to immediately resolve cash flow challenges or expand the business sooner than later. That’s where asset-based lending comes into play.
Asset-based lending offers an alternative for businesses that find it challenging to get funding from traditional lenders, such as banks.
How asset-based lending works
Businesses may need to take out loans in order to meet financial obligations that they encounter as part of their business operations. Most lenders will only offer unsecured loans to a company that has adequate cash flow. Otherwise, the lender may demand some form of collateral before the business owner can secure lending.
The easier the pledged collateral is to sell, the more favorable the loan terms will be. In case your business has to stop making repayments, collateral such as stocks and bonds can be easily liquidated on the market.
Lenders may accept more illiquid collateral, such as equipment or machinery, but the interest rates and fees tend to be higher while the loan amounts are often lower. Interest rates for asset-based loans are lower than their unsecured counterparts because the lenders may be able to recover some, if not all, of their exposure if the borrower defaults.
What are some types of asset-backed financing?
Asset-based loans come in a variety of forms. Depending on the specific financing requirements, companies can get asset-based loans in the form of term loans, lines of credit, receivables financing and inventory financing.
Term loans are structured as lump-sum loans with fixed periodic repayments over a set period of time. The repayments are typically either monthly or quarterly. Term loans can last anywhere from one year to ten years, outliers aside. Some of the most sought-after term loans are offered by the Small Business Administration (SBA).
Lines of credit
A line of credit is a business loan with a revolving credit limit that the borrower can access at any time until the limit is reached. As the borrower works to repay the loan, the business can continue to borrow from the credit line as needed.
Receivables financing is a type of asset-based loan backed by the receivables that a company expects to yield from their customers. Lenders typically give out 75% to 85% of the total value of the outstanding invoices in the form of loans.
Inventory financing is a loan designed to enable businesses to purchase products that will be sold later. The product inventory serves as the collateral for this type of asset-based lending.
Pros of asset-backed financing
Asset-backed financing is great for rapidly growing companies, businesses with a limited operating history or entities that are usually declined by more traditional lenders. Here are four advantages of asset-backed financing.
Easier to obtain than other types of loans
Asset-based loans are easier to obtain than unsecured loans because lenders of asset-based loans mainly assess the value and the quality of the pledged security. With unsecured business loans, lenders usually perform an in-depth analysis of the company’s financials, which may be difficult for newer companies to carry out.
Acts as a great source of liquidity
When properly structured, asset-based loans can infuse your business with much-needed liquidity. Enhanced liquidity will offer your company the predictability of consistent cash flow, which is necessary for the sake of easing tight cash flows and stabilizing operations.
Offers a lot of flexibility
Companies can use asset-based loans as they wish without facing any restrictions as to how they use the money. Lenders do not specify how the borrowing company must use the loan, as long as it is used for business purposes.
Less expensive than other financing options
Asset-based loans are often less costly than other types of business loans. This is mainly due to the pledged collateral that the lender can always take in the event of the borrower defaulting, which minimizes the risks of lending to businesses.
Cons of asset-backed financing
Now, let’s explore the disadvantages of asset-backed financing.
Not all assets will qualify
Your business may not have adequate collateral to take out an asset-based loan. Lenders have strict criteria for determining assets that can serve as collateral. Generally, they will prefer assets that can be quickly converted to cash.
There’s an inherent risk of losing your asset
You will naturally risk losing your pledged asset with this type of financing. This is dangerous because, should you default on your loan, you could lose an asset that is critical for the survival and growth of your company.
You won’t receive the full value of the asset
In most cases, you can only borrow between 75% to 85% of the value of your account receivables. You can only borrow about 50% of your equipment or inventory’s value as well. This might fall short in regard to your company’s funding needs.
How to qualify for asset-based lending
To qualify for an asset-based loan, your company has to present a well-detailed financial statement, a viable business model and an asset for the sake of security. The lenders may not pay much attention to your company’s credit history since an asset fully backs the loan.
Many financial institutions offer asset-based loans. These institutions include banks, asset-based lending companies and online lenders. You can also approach a loan broker who could potentially connect you with multiple lenders who might be willing to offer your business an asset-based loan.
What is a loan linked to an asset called?
A loan that is linked to an asset is called an asset-based loan. The asset is used to secure the lending, and in the event of default, the lender can retain the asset to recover its funds.
How do rich people borrow against stocks?
Rich people borrow against stocks via portfolio-based lending. Wealthy people can borrow against their stock positions and avoid paying capital gains tax as a result.
How big is the asset-based lending market?
According to Refinitiv data, in 2020, asset-based lending yielded a total of $72.4 billion USD.