Companies that seek financing to maintain and grow their business will look to traditional unsecured bank loans first because that is the more budget friendly form of borrowing available. However, many small businesses are growing fast, do not have a lengthy track record, or do not have a sufficiently high credit rating.
Due to these reasons, businesses are often turned down for a traditional bank loan. This has been true in the recent years in which lenders have become more cautious in their loan approvals. Often times small business that have lines of credit from banks cannot obtain additional funds since the bank will not extend additional credit beyond the current limit. Therefore, the bank will not finance their further growth.
In this situation, businesses can seek other forms of financing such as asset-based lending (ABL) which may meet the business’s need for additional financing.
Asset-based lending vs. Traditional lending
Asset based lending provides a more flexible approach to financing a business’s operations and needs for future growth. Traditional lending on the other hand is where is where the borrowing company’s operations are evaluated and its future cash flow is projected, asset-based loans are based on the collateral that is put up for the loan.
The most typical type of ABL is made against the business’s accounts receivables. The lender advances funds to the borrowing business based on the value of the receivables submitted to the lender. As asset-based loan typically takes the form of a revolving line of credit which is refreshed when the collateral, the receivables are paid down. While asset-based lenders also lend against other types of assets, including inventory, capital equipment, receivables are the largest proportion of collateral for these loans because they have greater liquidity.
Some of the collateral used to secure an asset-based loan includes the following:
- Accounts receivable
- Purchase orders
- Machinery and equipment
- Commercial real estate
- Marketable securities
- Intellectual property
The Lending Process
Asset-based lenders focus on the quality of the collateral rather than the credit ratio or cash flow of the borrower. They evaluate that creditor’s ability to make payment and their track record of past payments determine their creditworthiness. Traditional bank lenders are constrained by internal bank lending standards.
Banks will not lend to companies that have debt-to-capital ratios that are greaten than four or five to one. Independent asset-based lenders do not have the same constraints, instead they have the freedom to finance small businesses that are capitalized or otherwise do not meet traditional bank lending standards but are good businesses with bright long-term prospects.
Benefits of Asset-Based Lending
There are many benefits for the borrowers with asset-based lending. ABL provides immediate and on-going cash flow liquidity for a company’s working capital. This includes the purpose of supplies or materials, ability to meet seasonal requirements, to meet payroll, and other operating expenses the business incurs.
Asset-based lending requires less time to conduct the transaction while the lending process of a bank can take up to several months in some cases because the bank analyzes the borrower’s financial statements and credit history.
Since asset-based loans are based on collateral, lenders are more willing to be much more flexible and work with a borrower during a period of financial difficulty when the company’s finances are stretched. Asset-based loans do not rely on the performance of the borrower but instead on the quality of the collateral.
Asset-based lenders are not too concerned with personal credit histories or credit scores like banks are. Collateral is more important rather than the credit score or history of the borrower.
The Bottom Line
Borrowers that are seeking working capital financing need to consider the benefits for working with an asset-based lender because it can provide greater flexibility and options for businesses seeking to look beyond traditional bank loans. Traditional loans are helpful, but they can be difficult to apply for, as well as qualifying for. Consider asset-based loans as your funding go-to, especially if you feel that your credit score is not good enough.