You know what a loan is, how it works, and that there are numerous different types. One of these types is called an asset-based loan, (or ABL for purposes of this article), and it involves a borrower using his or her assets as collateral for a loan from a lender. The assets used are generally accounts receivable and/or current inventory. That’s the essential gist. Now let’s get detailed and find out if applying for an ABL is a good move for your business.
How an Asset-Based Loan works
Before Asset Based Loans are fully explained, it’s important to define some terms. Collateral, in terms of moneylending, can be thought of as security for repayment of a loan. As mentioned, it would come in the form of either accounts receivable, current inventory, or both. (Accounts receivable consists of money owed to a company for its goods or services. Current inventory refers to the total dollar amount of all on-hand stock).
Lenders in an ABL will issue funding based on a percentage of the borrower’s assets being used as collateral. For accounts receivable, this percentage usually hovers between 70% to 80% and for inventory, usually around 50%.
As a rudimentary example, let’s say you borrowed $50 from a lender under the terms on an asset-based loan. You’re currently owed $100 by a third party. You can use a percentage of that account receivable as collateral for the money I borrowed from you, in the event I can’t pay you back directly.
Knowing if an Asset Based Loan is Right
There are countless reasons for a business to apply for a loan. What you do with the money is your call and is part of the beauty of entrepreneurship. However, there are certain situations that an asset-based loan would fit more than a traditional loan might. According to Investopedia, “If the company seeking the loan cannot show enough cash flow or cash assets to cover a loan, the lender may offer to approve the loan with its physical assets as collateral. For example, a new restaurant might be able to obtain a loan only by using its equipment as collateral.”
Every business is different, though. The bottom line is that ABLs provide a low-interest loan that can cover short-term needs but should likely only be sought after by companies with financial stability. It would of course be the worst-case scenario for the business to have to liquidate the collateral used in an ABL in order to repay it, but still a good scenario for the lender, as repayment is guaranteed.
Small-to-mid-sized companies with financial security are the most common ABL applicants.
Applying for an Asset Based Loan
Asset-based loans are among the more common types applied for by businesses. There is a gigantic range of financial service companies that offer ABLs. This includes both banks and independent financial institutions. Small business owners, do not fear! It simply may take a little shopping to find a lender willing to offer a line of a credit. It’s far from impossible – especially if your company keeps detailed and accurate records and moves inventory/provides paid services at a regular rate.
Put your potential lender at ease by providing clean, accurate documents that show proof repayment will be made in a timely manner. If you have a good handle on a business that reports in the black and not the red, lenders will jump at the notion of funding you.
The Pros and Cons
As with nearly everything in life, there is a bright side and a dark side. Depending on the nuances of your business, the pros and cons of an ABL may differ drastically from what you see here, but in terms of averages, here are the pros and cons of an asset-based loan.
- There is an immediate increase in working capital upon approval.
- The approval process itself is quicker compared to that of traditional loans.
- As your assets increase, so can the amount able to be obtained by an ABL.
- Unlike with a traditional loan, which usually requires a specific purpose, an ABL can be used for anything that qualifies as a business expense.
- Responsibly handled asset-based loans will assuredly improve a business’ credit score.
- This one should be fairly obvious, but defaulting on payments could lead to losing whatever collateral assets are involved.
- Less obvious perhaps is that a company could end up with more debt on the loan than current collateral asset value. Default at this point could lead to losing more than the loan was originally for.
- ABLs do not increase the immediate worth of the company because they are secured loans than trade goods for liquified assets.
- For collateral, lenders will very likely sort through your accounts receivable and/or inventory and choose those which they deem most suitable. That being said, the credit line (and the chances of obtaining one) will only be as strong as the collateral.
- ABLs usually cost a little more than traditional loans in the end. There is a wide gap in their potential interest rates, and they sometimes come with ‘hidden fees’.
It goes without say to shop around for the best lender for you. Don’t just go with the hottest sale. Also, use due diligence in determining if the loan amount is truly worth what collateral you put up. There are numbers and then there’s your gut. Make sure what you’re paying for is worth the risk.
If you can pay the loan back in a timely manner, you find the pros to outweigh the cons for you, and you’re sure the financial shot in the arm will generate more profit in the end, an asset-based loan is probably perfect for you. Good luck and venture well!