How Does An Asset Based Loan Work?
This form of financing is ideal for a company which doesn’t want to have debts. It enables borrowers to be debt free and therefore eligible for more borrowing options.
Qualifications for ABL
Any stable small or mid-size company with assets can qualify for an asset based loan. However, the borrower must not have pledged the assets it uses as collateral elsewhere. If the asset the company intends to use is already pledged elsewhere, the other lender has to accept subordination of the position. Additionally, the borrowing company must not be facing serious accounting, tax, or legal issues which can encumber the used assets.
A percentage of the pledged collateral’s value determines the borrowing base. Generally, a business can borrow between 75% and 85% of its accounts receivable’s value. Equipment and inventory have a borrowing base of 50% or even less. Lenders often inspect assets and ledgers regularly to update and determine the borrowing base value. The borrowing base tends to fluctuate due to the involvement of accounts receivable.
Basically, lenders do their due diligence before giving out this type of loan. This involves calculating the collateral value, determining if the assets pledged as collateral have any encumbrance, and inspecting the borrower’s accounting book. What’s more, lenders make onsite visits to speak to some employees. Lenders charge varying costs for collateral evaluation and site visits.
The Bottom Line
An asset based loan is ideal for businesses in need of cash who cannot get it from traditional lenders for various reasons. An ABL comes with higher fees than a traditional loan but it might be the best solution for you if you need quick cash. It can also be an ideal long-term financing option for an established business with difficulties qualifying for an unsecured loan. However, this loan might not be ideal for start-ups without assets to secure against the loan.When a business is not profitable, has poor cash flow, and bad credit, qualifying for any loan can generally be difficult.
However, you can have your loan application approved with ease when you back it with a business asset. An asset based loan is a form of business financing which is secured by a business or company asset. In most cases, an ABL is structured like a revolving line of credit. With this structuring, a company can continuously borrow from its assets in order to cover investments or expenses as it becomes necessary.
Essentially, asset based lending entails loaning businesses money with collateral as security. Examples of the collateral which a business can use to secure this loan include accounts receivable, inventory, equipment, and other property which a borrower might own. This loan serves businesses and not consumers. It’s also called commercial finance or asset-based financing.
How it Works
To meet regular cash flow needs, most businesses need lines of credit or loans. For instance, a business can get a line of credit or a loan to cover payroll expenses. This can be necessitated by a delay in the payments a business expects from clients or customers.
Without proof of sufficient cash assets or cash flow to cover the loaned amount, the lender may ask for security of the physical assets owned by the business. For instance, a restaurant can use its equipment as security to obtain a loan.
Asset based loans can have different terms and conditions depending on the value and type of the asset used as collateral. Nevertheless, most ABL lenders prefer liquid collateral like securities. That’s because liquid collateral is easy to convert into cash in the event that the borrower defaults on the agreed payments. A loan secured with a physical asset is considered riskier. As such, the maximum amount loaned to the borrower is considerably lower than the assets’ book value.
For instance, a company can take out a £200,000 loan for its operations’ expansion. If such a company uses its marketable securities on the balance sheet as the loan’s collateral, it can get a loan of up to 85% of the securities’ face value. If the securities are worth £200,000, the lender can loan the company up to £170,000. On the other hand, if the company uses equipment, real estate or any other asset which is less liquid, the lender might offer 50% of the face value of the asset. Thus, the company can end up with £100,000 only.
Either way, the discount represents the expenses incurred when converting the used collateral into cash as well as the potential loss of market value. Asset based loans have lower interest rates than lines of credit or unsecured loans. That’s because lenders can recoup all or most of their losses if borrowers default on payments. Nevertheless, there is a wide variation in the interest rates which lenders charge. In most cases, the charged interest rates depend on the credit history, duration for which the borrower has been in business, and the cash flow of the borrower.
Benefits of an Asset Based Loan
There are many ways an ABL can benefit a company or business. Here are some of them:
Unlike a conventional loan, an asset based loan doesn’t need too much paperwork or documentation. Obtaining this loan is easy as long as the borrower meets the criteria the lender has set for asset based lending.
When facing tough economic times, an asset based loan can quickly cushion a business. It can also help in restoring a stable financial status. That’s because an asset based loan has a short processing period which increases the cash flow of the borrowing company.
Easy to Get
Compared to other lines of credit or loans, an asset based loan is realistically easy to qualify for. This is attributable to the fact that this loan involves few processes. The lender considers the collateral value and financial status of the borrower to determine their eligibility for the loan.
When it comes to restrictions, an asset based loan is more flexible. Basically, this form of financing doesn’t have strings attached as is the case with other types of loans.