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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.
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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
- Inventory
- Equipment
- Machinery
- Real estate
- Vehicles
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:
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.
Advantages
- 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.
Disadvantages
- 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.
Bottom line
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.
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