Two Main Types of Asset-Based Loans
Ezra Cabrera | March 18, 2019
If you’re like most business owners, you are always searching for new ways to maintain and grow your business. This can take a great deal of time out of your day and can end up costing you money. On the other hand, a company seeking to finance their growth and expansion oftentimes seek out traditional, unsecured bank loans. But as countless business owners have discovered, a traditional source of funding such as is available at a bank, can not only be extremely challenging but is very difficult to obtain, especially if you are a new business or start-up.
It’s no secret traditional bank loans have a stricter approval process…
On top of this, lenders have grown more cautious. This has become quite evident when one considers the ever-increasing and stringent, loan qualification processes a business owner must first satisfy in order to be approved as being worthy of financing.
For example, let’s assume your small business is in its infancy but yet is growing at a rapid pace. You won’t meet the requirement that stipulates your business has been in operation for the required minimum number of years. It’s also likely you will not have a high enough credit rating score, for the simple reason you haven’t been in business long enough to acquire the acceptable rating. Application denied!
Fortunately, small business owners have one other, a very attractive option called asset-based lending.
What is Asset-Based Lending?
Asset-based finance (also called asset-based lending or asset-based loans) is a type of financing that uses collateral to secure a loan, versus cash flow and credit. Traditional bank loans primarily consider cash flow first, collateral second. With asset-based loans, lenders consider collateral first and cash flow second.
When a growing business relies on collateral for financing, it can maintain the liquidity needed to keep up with capital requirements. Asset-based loans are quite frankly, a god-send for growing companies, and for a business in distress who find themselves with the need to recapitalize their balance sheet.
Refinancing existing term debt into a structured asset-based line of credit, can result in cash flow improvements as well as provide you with a much-needed injection of liquidity.
Most Common Types of Collateral for Asset-Based Loans
If your assets are physically or financially valuable and you can easily liquidate it into cash, then you may use them to secure an asset-based loan. While the type of collateral approved will vary depending on the lender, here are some of the assets that lenders usually accept:
- Accounts receivables
- Commercial real estate
- Machinery and equipment
Asset-Based Line of Credit
An asset-based line of credit is similar to a revolving line of credit, using underlying collateral to secure your loan. Some types of loans require that machinery and equipment be submitted as collateral due to its fixed value; while others will stipulate that inventory and accounts receivable are the necessary forms of collateral.
With an asset-based line of credit, it’s better to have a fixed collateral value as it will return a fixed amount of liquidity. Since inventory and accounts receivable are constantly changing, the amount of liquidity they return will fluctuate as well. With that said, if you purchase more inventory and make new sales, the value of your collateral will increase, resulting in more capital available on your revolving line of credit.
Asset-Backed Term Loans
An asset-based term loan uses the same collateral as an asset-based line of credit, but it’s structured as a term loan (as opposed to a revolving line of credit.) This term loan typically amortizes over one to five years, with monthly rates and interest payments.
Similar to the line of credit, it’s safer for businesses to use fixed-value collateral (real estate, machinery, and equipment) since lenders usually offer favorable terms for assets with a fixed, established value.
Are Asset-Based Loans the Right Fit for Your Business?
Deciding to apply for a loan is a major financial decision no business owner should take lightly. As the business owner, you’re the only one that could decide if an asset-based loan is right for your business. You’ll know this as you review the assets your business owns, your projected financial growth, your financial history, as well as the reason why you need a loan.
Business owners with good personal and business credit scores, a few years in business, and strong financials might benefit from traditional loans, which aren’t dependent on the value of your assets.
If you have a rapidly growing business that owns easily liquidated assets, asset-based loans can provide you with the funds you need to keep up with the growth of your business. This is especially beneficial for companies having a hard time qualifying for traditional loan options.