In this article:
- What is asset based lending?
- How does asset based lending work?
- What is an example of asset based lending?
- What are the advantages and disadvantages of asset based lending?
What is asset based lending?
Asset based lending is a form of short term financing where a line of credit can be secured using a business’s assets as collateral against a loan. It is an option for many businesses to help with short term cash flow problems and fund development projects.
Examples of assets that can be used include:
- Accounts receivables – invoices that are generally due within 30 to 90 days.
- Inventory – For a retail or wholesale operation with lots of stock at its disposal.
- Equipment or machinery – Usually of high value and owned outright by the business.
- Property – Property owned outright by the business.
- Intellectual property – Copyrights, patents, trademarks, inventions, images and website names.
How does asset based lending work?
As many lenders prefer to use assets that can be turned into cash quickly, they will often consider a business’s liquid assets (invoices and stocks) first to use as collateral. If a business would rather use their physical assets, or there is insufficient value in their liquid ones, then the physical assets are considered.
The lender will value the physical assets and as these are often considered a riskier form of collateral, the terms and conditions may differ between the two with the amount loaned possibly less - maybe around 50% of their value compared to as much as 90% for liquid assets.
Interest rates will also be charged on the loan based on the success of the business, its credit history and its cash flow.
What is an example of asset based lending?
A company would like to borrow £50,000 over a short term to help fund its growth and development. It can pledge its liquid assets and/or its physical assets.
It currently has invoices from reliable customers that are worth £50,000 so the lender can loan 80% of their value = £40,000. If however the company decides to pledge a building that is owned outright and valued at £60,000, then the amount loaned is likely to be around 50% of its value = £30,000.
In both cases the value loaned reflects the costs of converting the collateral into cash, which is likely to be incurred by the lender should the company default on its loan.
What are the advantages and disadvantages of asset based lending?
Advantages of asset based lending:
- Flexibility - There is no requirement to specify what the loan is needed for giving greater flexibility for its use. Once the loan has been approved and the funds received, the cash can be used wherever the business chooses.
- Quick processing - The funds, as long requirements for approval are met, are received quickly, unlike more traditional forms of bank loans.
- Competitive interest rates - Asset based loans often come with lower interest rates than other types of business loans, in particular unsecured business loans.
- Other financing options available - Using other forms of financing can be used alongside asset based financing
- Improves cash flow - It allows the use of untapped assets to help improve cash flow to grow and develop the business.
Disadvantages of asset based lending:
- Risking assets - It can be risky. If there is a failure to meet the payment terms then as the loan is directly tied to the asset and the business could lose an essential piece of machinery or building.
- Limit on borrowing - As the amount borrowed is based on the value of assets it may not be as much as required or needed.
- Undervalued assets - The lender controls the borrowing. Lenders will sometimes undervalue assets affecting what can be borrowed.
- Credit checks - Credit checks may be carried out by lenders before loaning cash. This will show up on a credit report and may affect credit rating and possible future borrowing.
- Charges - Defaults, late payments or paying the loan off early could incur charges. Late payments and defaults could also affect your credit score.