When a business has assets, and needs working capital to operate and grow, it may want to consider an asset-based loan or line of credit.
This type of business financing is known as asset-based lending.
Asset-based lending is a loan or line of credit issued to a business that is secured by some form of collateral. The various types of collateral used in asset-based lending includes but are not limited to inventory, equipment, accounts receivable and other balance-sheet assets.
This type of financing is best suited for a business that has assets such as large amounts of inventory, equipment, or accounts receivable, but needs funding to expand the business or get through a cash flow emergency.
Some loans or business lines of credit may be secured with only one asset, while others may be based on several assets being combined.
Business owners tend to resort to asset-based lending if they are unable to secure funding with a traditional lender or bank.
It’s important to note with asset-based lending that you don’t sell the assets. Instead, you are only borrowing against them. And since the asset is used as collateral, if the business fails to make the payments, the lender can take them.
In this article we will explore the positives and negatives of asset-based lending so you can determine if this type of financing is right for you.
The Upside
Easier to obtain than loans and business lines of credit
It is easier to qualify for an asset-based financing program because the major requirement is to have assets that can be leveraged. With asset-based lending, the collateral used to secure the loan or line of credit provides security to the lender.
Put valuable assets to good use
A business that has fixed assets on the balance sheet can leverage those assets to access additional working capital. Whether the company has invested in business equipment or inventory, those investments already made can be leveraged to secure additional funding for the business.
Greater flexibility than other types of financing
An asset-based financing program has very few restrictions on how the funds can be used, as long as it’s for a business purpose. Since the funding is secured to the value of your assets, the funding can increase as the value of your assets grow.
Lower cost than similar solutions
The majority of asset-based lending programs have lower costs than similar alternatives, such as factoring. While asset-based loans are priced with an annual percentage rate (APR), factoring lines are priced by discounting the full value of the invoice by a percentage.
The Downside
Not all assets qualify as collateral
Lenders have certain terms that an asset must meet before it can be used as collateral for a loan or line of credit. For an asset to qualify, it has to be of high value, low depreciation rate or high appreciation rate, and easily convertible into cash.
Higher cost than a traditional loan
Loan administration and origination costs for asset-based loans or lines of credit drive up the overall cost compared to traditional loans. The cost of initial underwriting and collateral assessment and monitoring is much greater and in-depth compared to traditional financing.
Risk of losing valuable assets
In the event the business fails to repay the loan, the lender can seize the asset that was pledged as collateral to secure the loan or line of credit. The collateral may be sold by the lender to recover the money that was issued to the borrower.
Before you decide on whether or not asset-based lending is right for you, consider the risks and benefits to your small business. Asset-based lending may be a viable option for the right kind of business in the right circumstances.
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