What is an Asset-based Loan?
An asset-based loan is a type of business financing where an individual takes a loan against his assets. These could be account receivables, inventory, equipment, or any other property. The lender (financial institution) offers the borrower an amount up to a certain percentage of the asset value. In most cases, the amount is usually 50 to 80% of the amount, depending on the type. Of course, receivables will have a higher percentage than equipment. In asset based lending, the loan is secure with existing assets, so financial institutions consider it less risky than unsecured loans. As a result, they charge lower interests. It’s even better if the assets are more liquid.
What Are The Qualifications for Asset-based Lending
Asset-based loans are for financing businesses and not individuals. Small to medium-sized companies usually take these loans due to cash flow problems to cover working capital needs.
Asset-based lenders consider stable small to medium size companies with assets that can act as collateral for loans. The stability indicators for small companies will be good financial statements, fast-moving inventory, and non-credit buyers. They also must not have a similar arrangement with other lenders. Lastly, they should have a clean accounting, legal, and tax record.
How Much an Asset-based Loan Costs
The amount of interest one incurs for this type of loan depends on the size and risk. The lender determines how much he will offer the business after appraising the assets and assessing the company ledgers. They will then calculate the amount using a loan-to-value ratio.
The interest rate charges will range between 7 to 15% per year.
Advantages and Disadvantages
Asset-based loans can be a handy source of business finance for businesses. It is especially when a company has reached its credit limit with vendors or the bank’s lending capacity. Other advantages are;
- They can boost the company’s liquidity and help stabilize its operations, especially for businesses experiencing high growth rates.
- Companies that use asset-based lending can improve their credit line when they use it correctly. The track record alone can allow them access to other less expensive finance options.
- They are faster and easy to get than other loans or credit lines.
- They have fewer bureaucracies and agreements.
- For companies using it as a revolving line of credit, the increasing inventory from additional capital also increases their borrowing base for future lending.
- They have lower interest rates in comparison to unsecured loans.
- An asset-based loan has a flexibility advantage over a traditional loan in that there is no restriction on its use as long as it qualifies as a business expense.
On the flip side, they come with constraints and may not be available for every entrepreneur and business.
- The most obvious disadvantage is the risk of losing assets if the company is unable to repay the loan. The lender’s security is fixed assets so defaulting is not an option.
- Asset-based lending only works for stable businesses. Small companies will find it hard to secure loans as lenders look through the quality of their receivables.
- Although cheaper than unsecured loans, asset-based loans are still more expensive than traditional loans. So the borrower has to determine if it is worth taking it to finance the business.
- More often than not, the financial institution requires that the borrower allows the customers to send to them directly during this period. That means they will be in control of the company’s account receivables. They can decide to take more if the cash flow increases.
- From time to time, the lenders will need to review the company ledgers and assets.
- The lender has to screen the business transaction to determine that the borrower can repay the loan in full, leaving little to privacy.
Is Asset-based Lending Right for Entrepreneurs
Considering the above pros and cons, is it a smart decision for entrepreneurs to utilize asset-based lending? Well, there is no one-fits-all answer. It will largely depend on the state of individual businesses. For instance, the stage of development; is it starting out or already established. The reason it needs a loan and the projected growth rate. As a general rule, before requesting a loan, the borrower must understand the use and ROI.
Veeramachineni Lalitha
I am Finance Content Writer. I write Personal Finance, banking, investment, and insurance related content for top clients including Kotak Mahindra Bank, Edelweiss, ICICI BANK and IDFC FIRST Bank. My experience details : Linkedin