Asset-based lending refers to business loans backed by collateral instead of based on your credit score. Here’s what you need to know to tell whether asset-based lending is right for your business’s financial needs.
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What is asset-based lending?
The amount of money a lender is willing to extend for an asset-based loan is based on the value of an asset held by the borrower. This asset is put up as collateral to guarantee the loan’s repayment. Approval for these business loans depends less on the borrower’s credit score and more on the asset’s value. If the borrower defaults on an asset-based loan, the lender has the right to repossess the collateral. [Follow our guide to choosing the right small business loan.]
“Asset-based loans are a way to get business financing by using company assets as collateral,” said Nishank Khanna, entrepreneur and vice president of growth at Utility. “The loans are usually secured by either equipment, real estate, accounts receivable or existing inventory.”
Asset-based financing used to be considered a last resort, but now it’s just one more way for businesses to access necessary financing for cash flow gaps and growth opportunities.
How does asset-based lending work?
Asset-based lending revolves around the asset or set of assets that will serve as collateral. The asset could be equipment the borrower owns, business inventory, real estate or even unpaid invoices.
Once an asset is put up as collateral, the lender will offer the borrower a loan worth an agreed-upon percentage of the asset’s value, Khanna explained. “Lenders prefer to offer larger loans because the cost to monitor an asset-based loan is the same whether the amount of capital being borrowed is small or large.”
The most common type of asset-based loan
To better understand asset-based lending, think of the most common type of asset-based loan: the mortgage.
“As the name indicates, asset-based loans put a physical asset up as collateral in case a loan is not paid back,” said Ty Stewart, CEO and president of Simple Life Insure. “The most common form of asset-based lending is actually home mortgages, though small businesses experience the exact same thing in the form of their commercial mortgage.”
With mortgages, you have a term (e.g., 30 years) and an interest rate (e.g., 4%) that will help determine your monthly payments throughout the life of the loan. Defaulting on the loan jeopardizes the collateral (in this case, real estate, such as a home or storefront) and allows the lender to repossess it to cover the loan.
Asset-based loans as revolving credit
In some cases, such as when they are based on outstanding invoices, asset-based loans can be structured as revolving credit, according to Jeffrey Bardos, CEO of Speritas Capital Partners.
“Each week or month, the lender determines the amount of accounts receivable and inventory, and this total translates into a ‘borrowing base,’ which in turn determines the amount of available borrowing capacity,” Bardos said. “Advance rates are established upfront for each type of collateral.”
Which assets can be used as collateral to secure a loan?
A business holds many assets it could potentially use as collateral to secure a loan. These include equipment, inventory, real estate and accounts receivable. Here’s a closer look at the types of collateral you could use to secure an asset-based loan:
- Accounts receivable: Invoice factoring is an asset-based loan that leverages the value of your existing accounts receivable. A factor (lender) will pay you a percentage of the value of your outstanding invoices and, typically, assume the responsibility of collecting the payments. While you don’t receive 100% of the value of your outstanding invoices through factoring, you do receive a lump sum of capital ranging from 75% to 95% of the total value. The remaining percentage, plus fees, is how the factor turns a profit. [Learn how to create an invoice.]
- Real estate: In some cases, such as a bridge loan, real estate serves as the collateral. For example, if you purchase a dilapidated property with the intent of rehabilitating it, a lender might offer you a bridge loan secured by the future redeveloped property. If you fail to make your payments and default on the loan, the lender could repossess the property you just redeveloped.
- Equipment: Equipment financing provides your business with the equipment it needs and uses that same equipment as collateral. If you don’t make the payments against the equipment, the lender can repossess it. Equipment financing is different from equipment leasing, where you rent equipment and pay interest and other fees.
- Inventory: You can use inventory financing to purchase goods for later sale. The inventory financed through this method will serve as collateral, much like equipment in equipment financing. Failure to make payments means the goods are subject to repossession by the lender.
Naturally, putting up these assets as collateral against a loan creates a big incentive on your end to avoid defaulting. Losing your commercial real estate, for example, could be a fatal blow to your business. Always have a plan for how you will pay back any amount borrowed before you accept a loan.
Invoice factoring differs from invoice financing. With invoice factoring, you effectively sell your invoices to a factoring company, whereas invoice financing has an underwriting process similar to when you apply for a business loan.
What are the pros and cons of asset-based lending?
Asset-based loans have some advantages over conventional loans, such as term loans from a bank or credit union. Fast funding and more flexible approvals make asset-based loans suitable for businesses looking to invest in a significant expansion, as well as businesses unable to access more conventional loans.
Pros of asset-based lending
- Asset-based loans are easier to obtain. The clearest benefit of asset-based loans is that they are relatively easy to obtain, even if you have less-than-stellar personal or business credit. Securing an asset-based loan is typically easier than securing a bank loan, which usually requires a good credit score, significant financial history, healthy debt-to-income ratio and more. Using an asset as collateral assures the lender that it can recoup the loan’s value even if you default. “Securing an [asset-based loan] should be fairly easy if your business has proper financial statements, inventory and products that have an existing market, and a history of paying bills on time,” Khanna said. [Learn some ways to build business credit.]
- Asset-based loans are approved and funded more quickly. Asset-based loans tend to be approved and funded more quickly than conventional term loans from a bank or credit union. “Asset-based loans can provide capital much quicker than other lending vehicles, specifically when you need funds for things like sudden expansions or ramped-up production,” Stewart said.
Cons of asset-based lending
- Asset-based loans place an asset at stake. The primary drawback of an asset-based loan is that you are putting an asset at stake – one that might be critical to your business’s survival and success.
- Asset-based loans risk your credit. Defaulting on an asset-based loan also impacts your personal and business credit. “The most obvious drawback is the double whammy of having your physical asset taken from you if you fail to pay back the loan combined with the hit to your personal and business credit scores,” Stewart said.
- Future lenders may view asset-based loans negatively. While an asset-based loan can get your business fast funding, even if your credit history isn’t great, other lenders could look upon it negatively if you seek additional financing in the future. You can typically mitigate this risk by limiting the value and number of asset-based loans you accept. “Small businesses too reliant on asset-based loans may wave a red flag if they approach other lenders, who may view this history as playing fast and loose with business decisions,” Stewart said.
- Asset-based loans have fees. Asset-based loans sometimes come with additional fees, such as a fee for any unused funds you borrowed, Bardos said. “Most asset-based loans have ‘unused fees,’ which can increase the effective cost of a facility. For example, if a small business obtains a $2-million asset-based loan, but only needs $1 million over the next 24 months, they may be charged an unused fee on the unused $1 million.”
Asset-based lenders to consider
If you’re considering an asset-based loan for your business, you have plenty of lenders to choose from.
“There is a wide range of asset-based lenders,” Bardos said. “The global and regional banks offer asset-based loans. Private, nonbank firms provide asset-based loans to small businesses. And there are numerous lenders who lend against one specific type of collateral, such as accounts receivable.”
Here are a few lenders that offer asset-based loans:
- Balboa Capital issues multiple types of asset-based loans to small businesses, including equipment financing. It also offers standard term loans.
- Crest Capital provides equipment financing options to small businesses, with loans ranging from $5,000 to $500,000. Read our full review of Crest Capital to learn more.
- Fora Financial is a versatile lender that extends asset-based loans to businesses in the form of equipment loans, inventory loans and bridge financing.
- Noble Funding offers asset-based loans to small businesses, including invoice factoring and lines of credit.
- Rapid Finance offers a wide range of financing options to small and midsize businesses. It also offers term loans, lines of credit, bridge loans, SBA loans, commercial real estate loans and healthcare cash advances. Visit our detailed review of Rapid Finance for more information.
- SBG Funding provides flexible loans to young businesses with a minimum credit score of 500 and $10,000 in monthly revenue. It also offers lines of credit, equipment financing and invoice factoring.
For more information on each of these lenders and how to choose the right business loan for you, visit our roundup of the best business loans.
Asset-based lending FAQs
How does collateral factor into asset-based loan qualification?
Traditional loans are based on credit and cash flow, while asset-based loans are based on underlying collateral and the company’s financial circumstances, ownership, and management. Compared to credit-based loans, asset-based loans can be easier to obtain.
Do asset-based loans have good interest rates?
Because asset-based loans are secured, they can be a very good deal compared to unsecured loans, as the interest rates tend to be lower.
I need to borrow a lot of money for my business. Will an asset-based loan help me?
It depends on how much you need. Asset-based loans are limited to an asset’s value, so their total value may be smaller than unsecured loans.
What can happen to the collateral if I can’t pay my asset-based loan?
The lender can claim the secured assets if you do not pay the loan as agreed. For this reason, it is crucial that you take out this type of loan only when you are sure you can make the payments over the entire term.
Erica Sandberg contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.