What is an Asset-Based Loan?

Options for financing a business extend beyond the question of debt vs. equity. Assuming that debt appears to be the best financing option for your company, the next question to answer is: which type?

An asset-based loan can be a great financing option under the right circumstances. This article will examine what those circumstances are to help you better understand whether or not an asset-based loan is right for your business.

What is an asset-based loan?

Asset-based loans are, as their names suggest, loans provided by banks against the value of a company’s assets. Relevant assets include: accounts receivables, inventory, and even fixed items like equipment and physical buildings. Typically, banks will be willing to lend 50-70% of the value of the agreed-upon assets.

Why would I want an asset-based loan?

Since banks providing asset-based loans have collateral to call in the event that the loan is not repaid, they may be willing to offer this type of financing for riskier projects. For instance, if your company is looking to start a new line of business, you may be able to borrow against the assets of your existing line to finance the development of your new line.

Also, assuming your company is in good financial health and that you have a steady stream of receivables, asset-based loans can also be among the easier types of debt to secure. As with any attempt to secure financing, it is important to be able to show the long-term viability of your business when pursuing asset-based financing.

Can my company pursue asset-based funding?

Naturally, to pursue asset-based funding, a company needs to have strong assets against which to borrow. As a result, SaaS and other web-based companies are typically not ideal candidates for banks to provide asset-based loans to (an exception might be Amazon, since it might look to pursue loans against its massive inventory holdings).

Companies considering the possibility of borrowing against their receivables must also consider the strength of those receivables. Receivables with uncertainty of being repaid are unlikely to be accepted by banks as collateral in a loan agreement, and it is possible that a bank will want to audit the firm on the paying end of an A/R to evaluate its likelihood of repayment. Thus, it is helpful to have long-standing customers or large firms as clients if you are seeking to use receivables as collateral. If your primary customers are small companies or your client relationships are not long-standing, you may need to borrow against other assets or pursue other types of debt.

What are the risks of asset-based funding?

Any time an asset is being held as collateral, there is risk that the asset could be lost, especially in cases where asset-based loans are being used to finance new ventures. While banks may be willing to finance riskier lines of business with asset-based loans, it is important that you be confident in your ability to repay the loan without surrendering an asset.

In the event that you choose your receivables as the asset to back your loan, it is very possible that the bank providing the loan to you will instruct your debtors to pay them directly. While this situation obviously streamlines your loan repayment process, it also takes a chunk of cashflow out of your hands, which can be an uncomfortable feeling. The potential loss of receivables is one factor to consider when deciding whether or not to take asset-based financing.

As Radio Shack recently discovered, a drop in the value of the asset used to collateralize your loan can also cause the bank to recall part, if not all, of your borrowed amount. This can throw the operations of any business into turmoil. As a result, as mentioned before, it is important to collateralize asset-based loans with stable, predictable assets.

The Bottom Line

For the right companies, asset-based financing can be an extremely effective means by which to take on debt. It can be easy to acquire and simple to maintain. It is important, however, that the assets underlying the loan are strong and stable. Uncertainty with underlying assets can cause banks to recall loan amounts or possess assets, scenarios that can do more to harm a business than the original loan did to help.