Should you consider an Asset Based Loan for your business?

What Is an Asset Based Loan?

An asset based loan (ABL) is a type of business financing that is secured by company assets. Most asset based loans are structured to work as revolving lines of credit. This structuring allows a company to borrow from assets on an ongoing basis to cover expenses or investments as needed.

Who uses asset based loans?

Asset based loans are used by companies that need working capital to operate or grow. Often, companies that request an ABL have cash flow problems. However, many of these cash flow problems stem from rapid growth. The asset based lending facility helps companies manage the rapid growth issues and positions the company for growth.

What businesses qualify for asset based loan?

Generally, asset based financing is offered to small and mid-sized companies that are stable and have assets that can be financed. The company’s assets must not be pledged as collateral to another lender. If they are pledged to another lender, the other lender must agree to subordinate its position. Also, the company must not have any serious accounting, legal, or tax issues which could encumber the assets.

Most asset based loans have a minimum of $750,000 to $1,000,000 in utilization requirements.

What assets can be used as collateral?

The main collateral for an asset based loan is usually accounts receivable. However, other collateral such as inventory, equipment, and other assets can also be used.

What is the borrowing base? How is it determined?

The borrowing base is the amount of money that the asset based lending company lets you borrow. The borrowing base is determined as a percentage of the value of the collateral that has been pledged. Generally, companies can borrow 75% – 85% of the value of their accounts receivable. The borrowing base of inventory and equipment is often 50% or less.

Asset based lenders inspect ledgers and assets regularly to determine and update the value of the borrowing base. Since it often involves accounts receivable, the borrowing base fluctuates.

How does the due diligence process work?

Before offering a loan, the lender needs to complete its due diligence process. During due diligence, the lender calculates the value of your collateral, determines if there are any encumbrances on the collateral, and inspects the accounting books. Lenders often do an onsite visit and speak to relevant employees.

Lenders often charge for the site visit and collateral evaluations, though costs vary.

What is the cost of an ABL?

The cost of an asset based loan is determined by the size of the loan, the type of collateral, and general risk. Most loans are priced using an annual percentage rate (APR). However, charges for other services are also common.

How is an asset based loan different from factoring?

Asset based loans are often confused with factoring. These products are different but provide similar benefits. Part of the confusion stems from the fact that both products use accounts receivable as their main collateral.

In a factoring transaction, the company does not borrow money. It sells its receivables to improve its cash flow. Receivables are sold on ledger individually, rather than financed in bulk. The factoring company is involved in the collections process.

What is the Security for Asset-Based Lenders?

The assets used as collateral for an asset-based loan are supposed to be at market value that the lender uses to determine the percentage that is given as the loan. If the borrower subsequently defaults on the loan, the lender is secured with knowing it can seize the assets that serve as loan collateral.

Once seized, the lender can then liquidate the assets and recover the amount it paid out as the loan. This is why asset-based lenders look closely at the assets being offered as collateral; that is the lender’s primary focus. If the borrower is in any way unable to repay the loan, the assets can be used to secure a return of the loan amount to the lender.

What are the differences between asset-based lending and traditional lending?

ABL provides a much more flexible approach to financing a business’s current operations and needs for future growth. In contrast to traditional bank lending, where the borrowing company’s operations are evaluated and its future cash flow is projected, asset-based loans are based on the collateral put up for the loan. The most typical type of ABL is made against the business’s accounts receivables. Here, the lender advances funds to the borrowing business based on the value of the receivables submitted to the lender. Typical advance rates are in the range of 70 percent to 90 percent. The creditors submit payment to the lender, and when the funds are collected, the lender provides the balance to the borrower, minus the fees it charges for the loan and for managing the collections process.

What is the lending process?

Asset-based lenders focus on the quality of the collateral rather than on the borrower’s cash flow or credit rating. They evaluate the creditor’s ability to make payment and their track record of past payments to determine their credit-worthiness. Traditional bank lenders are constrained by internal bank lending standards.

What are the benefits of ABL to the borrower?

Borrowers benefit from asset-based loans in a variety of ways. ABL provides immediate and on-going cash flow liquidity for a company’s working capital, including the purchase of materials and supplies, the ability to meet seasonal requirements, to meet payroll and other operating expenses and to keep their accounts payable current.

While a bank’s lending process may be lengthy and cumbersome—taking up to several months in some cases as the bank analyzes the borrower’s financial statements, credit history, and generally the entire business—asset-based lending requires comparatively less time to conduct the transaction. Further, because ABL loans are based on collateral, lenders are more often willing to be much more flexible and work with a borrower during a period of financial difficulty when the company’s finances are stretched.

Since asset-based loans don’t rely on the borrower’s operating performance, but on the quality of the collateral, fewer financial covenants are required of the borrower, and as compared with traditional bank lending, ABL lenders typically require a much more limited degree of reporting back to the lender.