Asset-Based Lending vs. Traditional Bank Lending: Which Should You Choose?

The least costly form of borrowing is to look to traditional unsecured bank loans. Many businesses are either growing fast, do not have a lengthy track record, or do not have a high credit rating. These businesses are usually turned down for a traditional bank loan. This is true especially due to financial crisis in which lenders have become more cautious in choosing who to approve for a loan.

Some businesses that have bank lines of credit cannot obtain additional funds from the bank, since the bank will not extend additional credit beyond the current limit meaning the bank will not finance their growth any further.

Whenever this happens and a business is short in working capital, businesses seek other forms of financing like asset-based lending (ABL) which might meet the business’s need for additional financing.

What is the difference between asset-based lending and traditional lending?

Asset based lending provides a more flexible approach to financing a business’s operations and needs to grow in the future. 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 accounts receivable of the business. 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.

An asset-based loan takes the form of a revolving line of credit which is refreshed when the collateral is paid down. Receivables are the largest proportion of collateral for these loans because they have greater liquidity.

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 want to make sure the creditor is able to make payments and their track record of past payments determines how credit worthy they are. Traditional bank lenders are constrained by internal bank lending standards.

Banks will not lend to companies that have debt-to-capital ratios that are greater than 4 to one. On the other hand, independent asset-based lenders are no subject to such constraints, giving them the freedom to finance many small businesses that are thinly capitalized or otherwise do meet traditional bank lending standards, but ae good business with bright long-term prospects.

Benefits of asset based lending to the borrower

There are many ways a borrower benefits from asset-based loans. ABL provides immediate and on-going cash flow liquidity for a company’s working capital, which includes 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, asset-based lending requires less time to conduct the transaction. It can take up to several months as the bank analyzes the borrower’s financial statements, credit history and more. Since ABL is based on collateral, lenders are more willing to be flexible and work with a borrower during a time of financial difficult when the finances of the company are stretched.

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

While determining your borrowing strategy should be individualized based upon each business and tailored to your business’s specific needs, borrowers seeking working capital financing need to seriously consider the benefits of working with an asset-based lender, as it can provide greater flexibility and options for businesses seeking to look beyond traditional bank lending.