As a small to medium sized business, there might be times when you need some financing to help your company. It could be to take advantage of an opportunity, meeting your payroll, or buying a new piece of equipment.
However, the lender isn’t confident that you have a cash flow to support making the payments and paying down the debt. If the lender offers asset-based financing, they can take an asset that you have as collateral and approve the loans. This can be a perfect solution for businesses that are growing, but don’t quite show it yet in the balance sheet.
Asset-Based Lending 101
In asset-based lending, an asset is used to secure the loan. The lender will take stock of what you have, and choose the most appropriate asset for collateral. It could be a piece of property, equipment, your inventory, or your building. For the lender, they know that their investment in you is pretty safe, since you have the asset to fall back on and give to them should you be unable to pay back the loan.
Because you’re using an asset to back the loan, you can expect a lower interest rate. The easier it is to convert the asset to cash by selling it, the lower your interest rate will be. For example, your accounts receivable can be an asset and is very easily liquidated, since most likely your customers will be paying. However, a property is more difficult to sell, so you can expect your interest rate to be higher.
You can take the credit as a loan or a line of credit. It can help you with any number of situations, such as debt refinancing, working capital, mergers, restructuring, or to get over the hump while your business is off-season. It’s really up to you.
Lenders have the option of securing the loan with a single asset, or several assets. They will assess the value of the asset, and also how well it’s been maintained. A piece of equipment that’s worn down, or a property gone to seed will not be worth as much to a lender as something that is pristine and well taken care of.
How Asset-Based Lending Can Help You
For starters, you can access credit when maybe you wouldn’t have qualified before. If you have bad credit or you’re just getting started and don’t have much history, it can be a big help. Businesses that are seasonal, and businesses that have thin margins can really benefit from asset-based financing.
On top of that, you can get approval very fast. The funds can be in your account in a matter of days so you can use it quickly. You can also use the funds for almost anything, so there is flexibility. There are no restrictions put on your usage, so you can make a purchase, refinance, or both. Funds will greatly improve your cash flow. Cash flow is something that too many businesses overlook, when they really shouldn’t. You might end up having a number of bills to pay, including payroll, and unable to pay them.
Drawbacks of Asset-Based Financing
The biggest drawback is that your asset is at risk. You would hope that you would be able to make the payments, but there are no sure things in life. You could end up having your asset seized if you are unable to make your payments. Also, because there is more work on the lender’s part, some of the fees involved with applying and processing the loan might be higher than you would normally see.
How The Amount Is Calculated
To determine the amount that your asset secures for the loan, lenders use a formula to determine the loan to value ratio. They would look at the loan amount you are asking for, and then compare it to the value of the asset.
If you want an asset-based loan to work for you, then you need to be sure that you can make the payments on it. You may get the funds to finance whatever you need, but if you are only going to default, then it will not have been a good move.