One Solution: Asset-Based Lending
A potential solution to this dilemma is a unique type of business financing known as asset-based lending, or ABL. Unlike traditional commercial loans that are based primarily on financial ratios and credit history, ABL can also rely on the value of a company’s assets that can serve as collateral. These typically include inventory and accounts receivable, and to a lesser extent, machinery, equipment and real estate.
Most asset-based loans take the form of a revolving line of credit. The credit line is based on a borrowing base of the value of the assets serving as collateral and an advance rate that’s based on the type of collateral being pledged. When a financing request is approved, funds are deposited into the business’ bank account and the transaction settles once the assets are converted to cash (i.e., when invoice payments are made to a lockbox or specially designated account).
Accounts receivable tends to be the most common type of asset pledged as security for asset-based loans since it’s easy to measure the value of AR. Asset-based loans of up to 85% of the value of accounts receivable are common. Advance rates on other types of assets like inventory and equipment tend to be lower (typically around 50%) due to their lack of liquidity. Some lenders will consider other asset classes based on additional due diligence and their expertise, including without limitation, litigation finance, medical liens, structured settlements and private mortgage notes.
Pros and Cons of Asset-Based Loans
Could your business benefit from an asset-based loan? Consider the potential advantages and disadvantages of ABL. On the positive side, asset-based lending:
- Maximizes borrowing capacity and improves liquidity.
- Helps seasonal and high-growth companies overcome cash flow challenges.
- May be easier to obtain than traditional types of financing.
- May be less expensive than factoring and some other types of alternative financing.
However, there are some potential drawbacks to ABL. For example:
- Lenders may implement more stringent monitoring and reporting requirements with asset-based loans, including audits and monthly collateral reporting.
- Administrative overhead costs may be higher than conventional bank loans.
- Receivables pledged as collateral must be from creditworthy customers, as determined by the lender.
Asset-based loans are sometimes a temporary financing solution, providing much-needed working capital until a company makes it through a start-up or transitional phase and may qualify for a traditional bank loan or line of credit. They can also provide additional financing in addition to a bank loan or line to help businesses take advantage of unexpected opportunities, like an unexpected large order or an opportunity to purchase inventory at fire-sale prices. Many clients find that the discipline associated with an asset-based lending facility aids in the prudent management of their business and its cash flows.
Choose Your Asset-Based Lender Carefully
When applying for an asset-based loan, it’s important to work with a specialty lender with deep knowledge of this unique type of financing. Firstrust’s Specialty Financing Services department features experienced asset-based lenders who have the flexibility to develop creative loan structures. All credit decisions are made and loan servicing is done locally so you don’t have to work with out-of-town bankers who don’t understand your business.
Visit Firstrust Bank online to learn more about our Specialty Financing Services, including asset-based loans. Or contact your Relationship Manager.