What is asset-based financing?

Asset-based lending lets you secure a loan for your business using inventory, equipment, accounts receivables and more.

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What is asset-based financing?

Asset-based financing – also called asset-based lending (ABL) – is a type of business financing backed by anything your business owns that has cash value or, in other words, its assets. This means that if your business can’t pay back the loan, your lender can take and sell these assets to make up for the loss. Typically business owners use asset-based lending for working capital or to fund new projects.

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.

While it’s possible to get an asset-based term loan, business lines of credit tend to be more common.

How does asset-based financing work?

Asset-based lending works a lot 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 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 as high as 90% because they’re fixed values that won’t change. With an asset-based line of credit, your lender regularly re-evaluates the value of your assets to adjust your borrowing base.

Let’s look at an example: 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. 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.

What types of assets can my business use to back a loan?

Almost anything your business owns that has a cash value. Some common assets include but aren’t limited to:

  • Inventory
  • Accounts receivables
  • Equipment
  • Machinery
  • Real estate
  • Vehicles

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 for asset-based financing?

Whether or not your business qualifies for an asset-based loan generally depends on your business’s assets more than anything else. 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. Typically, lenders require businesses to have assets with a borrowing base of at least $700,000. This means that between 75% and 85% of your assets’ value must be at least $700,000.

How to apply

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 asset-based financing

Advantages

  • It’s easier to be approved for these type of financing agreements. As your loan is secured against the assets borrowed, it’s often possible to be approved without a great business credit score.
  • Upgrade your equipment. Investing in equipment allows you to operate at higher capacity and bring in more revenue.
  • You may be able to lease equipment. Some lenders may allow you to lease equipment and buy it after the lease expires. Plus, with some leasing deals, the lender is responsible for maintaining the equipment.
  • Reinvest in other aspects of your business. With a loan to cover the cost of equipment, you can use your business’s cashflow to reinvest in other needs such as hiring and training, marketing or increasing your inventory.
  • Seasonality doesn’t matter. Manufacturers, distributors and other businesses that have seasonal drops in cash flow could particularly benefit from asset-based lending.
  • Timely repayments will boost your credit score. This will make it easier to access other credit products for your business like commercial real estate financing, business credit cards and other loans.

Disadvantages

  • More fees than other types of financing. You’ll likely need to cover the cost of the due diligence process, which can get pricey depending on how long it takes.
  • Not for new businesses. It’s easier for established businesses to meet the minimum borrowing requirements and show its business financials are strong enough to qualify for a loan.
  • Potentially costly It’s more expensive to finance an asset than buy it outright.
  • Risk losing your assets. Your assets will be repossessed if you fall behind on repayments.
  • May require an deposit upfront.

How is asset-based financing different from a secured business loan?

While asset-based lending and secured business loans are similar, they differ by how lenders determine your loan amount. Asset-based lending determines loan amounts based on the value of what your business owns, such as accounts receivables or real estate.

Secured business loans are typically backed by one specific asset like a piece of equipment or vehicle stated in the terms. Often, businesses use the funds from a 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 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 — less a fee.

Asset-based financing is generally a better option for more established businesses. Many asset-based loans start with a borrowing base of around $700,000, while factoring typically has a much lower minimum — if any at all.

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? Visit our guide to compare lenders and find out how different types of financing work.

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