Almost all businesses require external funding at some point. Loans and lines of credit can help you grow, keep you afloat during a cash flow lull and even help mitigate downturns in the economy. However, you won’t always qualify for a traditional bank loan for the amount you need when you need it. That’s because banks typically expect businesses to be well-established, have a good credit score, have reliable cash flow, and meet other criteria that’s not necessarily feasible for startups and most small-to-midsize companies. This is where asset-based lending options come into play.
Asset-Based Lending Requires Collateral
The term may be self-evident, but asset-based refers to using collateral to back a loan. Virtually anything of value can be used as collateral, though lenders tend to focus more on things that can be liquidated easily if need be, such as equipment or invoices.
It’s Can Be Easier to Qualify for an Asset-Based Loan than a Conventional Loan
Banks place a great deal of scrutiny on borrowers because the loans are typically based on two things: the borrower’s ability to pay, and the likelihood that the borrower will pay.
Asset-based lending options are easier to qualify for because the lenders are looking at different criteria. The biggest part considered is going to be the value of the asset being leveraged and its ability to be liquidated. That doesn’t mean you’re necessarily giving up the asset, only that it could be sold easily if you fail to make good on your loan.
Asset-Based Loans Can Work Like a Line of Credit or Term Loan
Let’s say you’re using your invoices as collateral for your asset-based loan. In this case, the lender will establish how much your outstanding invoices are usually worth and will then offer you a loan worth up to a certain percentage of the value. For example, if you usually have $10,000 in outstanding invoices at any given point, the lender may offer you up to 90% of the value, which amounts to $9,000. That $9,000 is yours to tap into just like you might a credit card, making it a form of a line of credit. You’ll make monthly payments and pay interest on it as well. However, once you’ve spent all $9,000, you are tapped out until you reduce the balance owed. If you pay $1,000 on it the next month, you could, in theory, spend that $1,000 right away again, though.
On the flip side, some asset-based loans are term loans. Let’s say you own a work truck worth $20,000. It’s paid in full, and you own it outright. Again, you won’t be able to get the full value of it, but perhaps you need $10,000 to buy supplies. You could get a loan using the truck as collateral. You’ll make monthly payments with interest toward the balance until it’s paid off. Some asset-based loans are interest-only during the life of the loan, with the full principal being due at the end of the term. You’ll see this more when the asset being leveraged is real estate.
There are Pros and Cons to Asset-Based Lending
Like any form of funding for businesses, there are pros and cons to asset-based lending. It doesn’t always make sense for all businesses or at all times. In those cases, you should seek out alternatives.
Easier to Qualify: As noted earlier, it’s easier to qualify for an asset-based loan because eligibility rests mostly on the value of the asset you’re leveraging—not your credit, cash flow nor your time in business.
Faster Funding: Conventional lending has more regulatory hoops to jump through, so it can sometimes take weeks or months to get cash. With asset-based lending, you could be funded in days.
Less Risk to Personal Property: Most small business owners wind up putting their own assets, like a family home, on the line when they get a conventional loan. With a business asset-based loan, the only thing that’s really at risk is the asset you’ve chosen to leverage.
Costs More: Although asset-based lending fills a major gap for borrowers who may not qualify for traditional lending, the fees are usually considerably higher. If you can qualify for another form of lending, and it will meet your timeline, you should probably explore that option first.
Risks Business Assets: If you fail to make good on your loan payments, it’s not just your credit score on the line. Chances are, you will lose the asset you leveraged.
Unclear Terms: Government regulations are different for certain loans, so it’s not always easy to tell exactly how much you’re paying to borrow or whether your payments are going to interest or the principal. You must do your homework and read the fine print.
Debt Cycle: Particularly when it comes to lines of credit, it’s all too easy to get caught up in a debt cycle, paying down a debt, and then racking it right back up again. If you’re struggling in this regard, you may want to seek out alternatives that can improve your cash flow without putting your business in debt.
Four Most Common Types of Asset-Based Loans for Businesses
1. Accounts Receivable
As mentioned earlier, businesses can get cash for their unpaid invoices or receivables. For example, if you invoice your customers for goods or services and then give them 30, 60, or 90+ days to pay, a lender may give you cash worth up to a certain percentage of your receivables. This is typically done up as a line of credit but could be done as a term loan, too.
Accounts receivable financing is not the same thing as invoice factoring, though the two are commonly confused. With invoice factoring, you’re selling select invoices to a factor. The factor pays you right away. However, as the new owner of the invoices, the factor then takes responsibility for collecting from the customers. There’s no need to pay anything back because it’s not a loan.
Wholesale, manufacturing, and retail businesses often have surplus inventory on hand. A lender can appraise the value of your surplus and provide a term loan based on the findings. For example, if you run a company that sells holiday décor and have a ton of Christmas lights collecting dust in July, but no money to cover payroll, you can borrow against the lights. Of course, you’ll want to crunch the numbers here to ensure you’re not paying more to borrow the money than you would have by running a big sale and liquidating the lights on your own.
Almost any type of equipment owned outright by your business can serve as collateral. A trucking company could use its trucks or computer systems, a restaurant could leverage its kitchen equipment, and so forth. This works well for businesses that are in a pinch for cash and don’t want to sell anything that’s needed for daily operations. However, it’s important to remember that any equipment used as collateral could be lost if you don’t make your payments.
4. Real Estate
If your business owns property or raw land, this can be leveraged as collateral, too. Few businesses are able to do so because they already have mortgages on the property and, naturally, you can’t leverage something that’s already leveraged. You’ll likely need to own your real estate outright, though some lenders will provide a loan if you have a significant amount of equity in the property. For example, if you owe a mortgage company 50 percent of the value, you may be able to pull out another 20 or 25 percent through a separate asset-based loan, though it is difficult to find lenders who will fund you.
Get an Instant Factoring Rate Quote
If your business doesn’t qualify for traditional lending options or you need cash quicker than they can provide, invoice factoring may be a better solution for you. Best of all, it doesn’t require you to risk assets and you won’t be racking up debt. Get an instant factoring rate quote from Interstate Capital now.