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Asset-based financing explained
How you can use your inventory, accounts receivables and more to secure a loan for your business.
Qualifying for a loan is often difficult if your business has bad credit, poor cash flow or isn’t currently profitable. But backing a loan with your business’s assets can make it easier to get approved by taking some of the risk off the lender. It can still take months to get financing, however, so it’s not the best option for emergencies.
What is asset-based lending?
Asset-based lending is a type of business financing backed by anything with a cash value in your business’s name — in other words, its assets. This means if your business defaults on the loan, your lender can make up for the loss by taking and selling the assets used to secure the loan.
Asset-based loans are riskier for the borrower — your business stands to lose big if it folds. But if you’ve had trouble qualifying for traditional loans in the past, you may have an easier time getting access to funds with this type of financing.
Typically business owners use asset-based lending for working capital or to fund new projects. While it’s possible to get an asset-based term loan, lines of credit tend to be more common.
How does asset-based lending work?
Asset-based lending is a type of secured financing — like a secured business loan or line of credit. How much you’re eligible to borrow — called the borrowing base or loan-to-value (LTV) ratio — depends on the value of your assets. Typically, your business can borrow between 75% and 85% of the total value of your assets.
Your borrowing base often depends on the type of asset you’re using. For example, the LTV ratio for loans backed by equipment or inventory can be 50% or lower since their values can decrease over time. Meanwhile, accounts receivables can get you an LTV ratio as high as 90% because they’re fixed values that won’t change.
An asset-based loan requires a one-time check of the value of your business’s assets. With an asset-based line of credit, your lender regularly reevaluates the value of your assets to adjust your borrowing base and rates.
LTV ratio in action
Say a business owns $10,000 of equipment and applied for an asset-based line of credit.
It originally qualified for a credit limit of $5,000 — a 50% LTV ratio. But after the value of the equipment depreciated to $8,000, it could only qualify for a $4,000 credit limit with a loan backed by those assets alone.
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What types of assets can my business use to back a loan?
Almost anything your business owns that has a cash value can be used to back a loan. Some common assets used as collateral include:
- Accounts receivables
- Real estate
How is asset-based lending different from a secured business loan?
An asset-based loan or line of credit is a type of secured financing. Asset-based lending determines loan amounts based on the value of what your business owns and is willing to offer as security, such as accounts receivables or real estate.
While a simple secured business loan is typically backed by one specific asset like a piece of equipment or vehicle stated in the terms, an asset-based loan would likely use several. Often, businesses use the funds from a simple secured business loan to purchase the asset it’s using as collateral. For example, if a restaurant took out an equipment loan to buy an industrial dough mixer, it’d use the dough mixer as collateral for the loan.
Asset-based financing vs. factoring
The fundamental difference between asset-based lending and invoice factoring is how it works. With asset-based financing, your business takes out a loan based on the value of items it owns. With factoring, your business sells one of its assets — its unpaid invoices — to a third party.
With asset-based financing, you pay off your loan plus interest and fees in regular installments over a set period of time. Factoring is typically a two-part deal: You get part of the funds upfront and the remaining value of your invoices after your clients pay up — minus a fee.
How much does it cost?
Asset-based loans can be less expensive than your average term loan. Typically, the APRs on asset-based loans range from 7% to 17% — though they’ll vary depending on your specific situation.
On top of interest, you might have to pay to have your assets evaluated. How much you’ll fork over for an appraisal depends on the type of asset. Accounts receivables are typically easiest to assess, while inventory, machinery and real estate might require a site visit.
Can my business qualify?
Your business’s assets determine whether you qualify more than anything else. But cash flow and credit still play a role. Typically, your assets must:
- Not be used as collateral for another loan. If your assets are already being used as collateral, then you’ll need to get your lender to agree to take the collateral off the loan.
- Not be tied up in any accounting, tax or legal issues. This includes tax liens and lawsuits that could affect your business’s ownership of the assets.
- Meet the lender’s minimum borrowing requirements. Minimums can vary by lender, but typically start around $5,000. Depending on the approved LTV ratio for your assets, you could need assets ranging in value from $5,600 and $10,000 to meet that minimum.
How to apply for an asset-based loan
One of the drawbacks of asset-based lending is that the application process is much more involved than your standard online loan. There are a few reasons for that.
Asset-based lines of credit typically involve long-term relationships between the lender and the business, so lenders often want to make sure that they’re dealing with a trusted partner. Also, getting an accurate evaluation of your business assets’ worth can take some time and work.
Typically, you’ll follow these steps:
Step 1: Review your financials
First, get an idea of where your business stands financially to help you decide if an asset-based loan is the right fit. To do so, take a look at the most up-to-date versions of the following documents — your lender will likely ask to see them anyway.
- Balance sheets. This is where you’ll get a preliminary idea of what your business’s assets are and if they have enough value to qualify for a loan.
- Profit and loss (P&L) statements. A year-to-date profit and loss statement gives you an idea of your business’s current cash flow, and your previous year’s annual P&L statement helps you determine seasonal trends.
- Tax returns. Look at the past three years of your business’s tax returns to grasp how your business handles revenue. If your company is relatively young, include your personal tax returns.
- Business bank statements. Business bank statements are one of the most common ways for lenders to assess day-to-day profits and losses. Review at least four months of your business bank statements — or a year if you have seasonal sales.
- Sales forecast. Asset-based lenders often give as much weight to your business’s future sales as its sales history — if not more. Have a firm grasp of where your business is heading before you start looking for an asset-based loan.
Step 2: Review your assets
After reviewing your business’s balance sheets, identify the assets that your business could use as collateral and take a closer look at what you’re working with. Start by reviewing some or all of the following documents.
- Accounts receivables aging statement. Accounts receivables are the most common type of collateral used for an asset-based loan. An aging statement shows the value of your invoices, when they’re due and any overdue stragglers.
- List of equipment. If you don’t have an updated list of your company’s equipment, make one. Includes in-store fixtures and appliances — like your cash register — as well as heavy machinery and vehicles. For each item, list the price you bought it for, whether you got it used or new, how old it is, where it’s located and its condition.
- List of inventory. Review or create an up-to-date list of your business’s inventory and its estimated value for resale — the amount your lender could sell it for, not the retail value. Also make a note of where it’s stored.
Bonus points if you can estimate the current value of your equipment by looking into depreciation values or getting it appraised — you can do this online for free with vehicles and some other items.
Step 3: Double-check your debts
Now that you know what assets you can use to back your loan, make sure that they aren’t tied up in anything else. If your business is facing a lawsuit that could affect its assets, hold off on applying until after the suit is over. And settle any unpaid taxes if your business has a tax lien on its assets.
While you might be able to qualify for an asset-based loan even if you’re using some of your assets as collateral for another loan, you’ll likely have a better chance of getting approved if you close those debts first.
Step 4: Compare lenders
Once you have an idea of what you’re working with, start comparing lenders that offer asset-based financing. Ask yourself the following questions to make sure you find the right loan for your business:
- Is my business eligible? This typically falls on the value of your business’s assets. If the lender doesn’t mention a borrowing base minimum online, call and ask if it has one.
- What are the rates? Since asset-based loans are less risky for the lender than unsecured loans, you can typically find lower rates between 7% and 17% APR. Comparing APRs on lines of credit is the easiest way to tell which will cost your business less in the long run. If you’re comparing loans, make sure they have similar terms.
- What are the fees? If the lender doesn’t mention fees, reach out and ask what you can expect to pay up front.
Step 5: Fill out and submit the application
Once you’ve found a lender that works for your business, complete and submit the application. Many allow you to do this online, though some banks and credit unions might ask you to visit them in person.
You might be required to submit a few preliminary documents like bank statements along with your application. Some lenders could require a financial audit by a third party. Reach out to your lender if any part of the application is unclear.
It can take up to a month for your lender to review your application.
Step 6: Agree to due diligence
The due diligence proces convinces your lender that your assets are worth what you say. Here, your lender calculates your business assets’ value, checks that they aren’t being used as collateral for anything else and inspects your accounting book.
This typically includes a field audit, where a lender representative visits your business to check out your office space, review your account receivables and financials and inspect any equipment or machinery offered for collateral. Since asset-based loans are typically long-term financial commitments, your lender typically uses this visit to determine if the two of you can sustain a long-term relationship.
Step 7: Wait for approval
Generally, you’ll have an idea if you’re approved by the end of the field audit. But you won’t know for sure until your lender fully assesses your assets and application and gives you a final offer.
Review, sign and submit your loan documents once you get the green light from your lender and wait for your business to receive its funds.
Advantages and disadvantages of an asset-based business loan
Determine whether an asset-based loan is right for your business by weighing the pros and cons.
- Competitive rates. Loans backed by collateral typically have more competitive rates than unsecured business loans.
- Seasonality doesn’t matter. Manufacturers, distributors and other businesses that have seasonal drops in cash flow could particularly benefit from asset-based lending.
- Your credit doesn’t count as much. Even though your lender will likely check your credit score, it typically won’t hold as much weight as it would with unsecured financing.
- More fees than other types of financing. You’ll likely need to cover the cost of the appraisal and other due diligence, which can get pricey depending on how long it takes.
- Long turnaround time. Applying for asset-based financing can take anywhere from weeks to months, so it’s not ideal for an emergency cost.
- Not for new businesses. While time in business might not be as important for asset-based lenders, it’s easier for established businesses to meet the minimum borrowing base requirements and show its financials are strong enough to qualify for a loan.
Asset-based loans could be a good long-term financing solution for established businesses that have trouble qualifying for unsecured business loans due to gaps in cash flow or bad credit. It’s not great when you need quick or small-dollar funding, and you could have trouble qualifying if your business is just getting off the ground.
Interested in learning more about your business loan options? Read our guide to compare lenders and find out how different types of financing work.
Frequently asked questions
Is a loan considered an asset?
Not for a business that’s paying it back. In this case, it’s considered a liability. Loans are only assets for the lender, since it’s money it stands to collect.
Can my business use an asset-based loan for a merger or acquisition?
Yes. In fact, an asset-based line of credit can help your business cover working capital costs while its funds are tied up in the transition. And once the merger is complete, you can use your business’s new assets to increase the credit limit.
Can healthcare companies qualify for asset-based lending?
Yes. Some lenders specifically offer asset-based lending options for healthcare companies and hospitals.
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