asset based business loans

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What are Asset-based loans and how do they work?

Asset-based loans (ABL) are more commonly called secured loans because they require that the borrower pledge an asset in order to receive the funds. The asset acts as collateral for the issuing lender and in the event that the borrower defaults on the terms of the loan, the financial institution will seize the asset as repayment for the debt. Asset-based lending works like any other small business lending option, where the borrower receives a lump sum of money and repays the entire loan amount plus financing costs to the issuing lender. The difference is that asset-based lenders secure the funds they issue with tangible or non-tangible assets, called collateral.

What is collateral?

Collateral is any asset accepted by the lender to secure a loan. Asset-based lenders typically prefer collateral that can be easily liquidated into cash if the borrower defaults on the loan agreement. Some examples of collateral for a business ABL may include:

  • Commercial real estate, like land or buildings
  • Equipment
  • Inventory
  • Accounts receivable
  • Business or the business owner’s personal investment accounts, like an IRA or 401K
  • Personal savings accounts
  • Investments, like stocks and bonds
  • Residential real estate
  • Jewels, antiques, or vehicles

How are asset-based loans different from other business loan options?

If a small business loan does not require the borrower to pledge any asset as security it is considered an unsecured business loan. Unsecured loans are approved and issued on the borrower’s creditworthiness, which analyzes the business credit history, personal credit scores, annual revenues, time in business, payment history, and debt-to-income ratio.

Types of asset-based small business loans

Most types of small business loans can be set up as asset-based if you are working with a bank, credit union, or online lender that issues asset-based lending options. Some types of business financing that are commonly set up as ABLs include the following.

Commercial real estate (CRE) loan

CRE loans and business mortgage loans are considered asset-based lending because when a borrower receives a loan to purchase land, buildings, or office space for their business, the loan is secured by the asset that is being purchased. The lender has the right to seize the newly purchased or renovated property if the borrower defaults by placing a lien on the property. Purchasers will not be provided the title for the real estate until the debt is repaid in full.

Merchant cash advance (MCA)

A merchant cash advance is a legal agreement between an entrepreneur and a financial institution or merchant lending company. MCAs work when the borrower receives a cash advance payment and pledges future credit card and debit card revenue as collateral. The lending institution then collects a percentage of sales as repayment. MCAs are a great financing option for retail and restaurant businesses that need to supplement fluctuations in cash flow or cover a one-time expense, like a repair or renovation.

Equipment loans

Equipment financing is a small business loan option used to make large purchases, like machinery, business equipment, computer hardware and software, and vehicles. Equipment loans are popular because they allow borrowers to finance 100% of the equipment price. The purchased equipment then becomes the collateral on the debt, so the loan term is typically the same as the estimated useful life of the asset.

Asset-based business line of credit

A secured line of credit is a type of financing that works similarly to a business credit card. Once approved, the borrower can access funds within their preapproved credit limit at any time with no second application. When working with an asset-based line of credit a hard asset, is pledged as collateral, to secure the credit line and minimize risk for the lender. Typically, asset-based lenders can extend a secured line of credit worth 70 to 90 percent of the asset’s value.

Invoice factoring or invoice financing

Invoice factoring and invoice financing are types of business funding programs where the small business’s accounts receivable balance, or unpaid invoices, act as collateral for the loan. Invoice factoring is when small business owners sell their unpaid invoices to a third-party factoring company, who collects on the invoices and disburses the balance, minus the fees they charge, back to the small business. Invoice financing is a similar financing option where the borrower receives upfront cash or a line of credit. The unpaid invoices, which have to be collected by the borrower, then act as collateral on the funds.

Short-term loan

Short-term loans are a common ABL used by entrepreneurs that need to temporarily increase their working capital, make a large purchase, or cover startup costs. The loan terms for short-term loans are typically 18 months or less and require some type of collateral, like a personal savings account or business assets. Short-term loans have higher interest rates than some long-term financing options but can be a great solution for fast funding.

The benefits of asset-based loans for business

ABLs provide an alternative financing option to traditional bank loans, unsecured lines of credit, and government-backed funding programs, like SBA loans. However, just like every business decision, there are pros and cons of asset-based lending. Let’s first look at the benefits of asset-based loans.

Increased approval odds

Asset-based loans provide an alternative for small business owners with bad credit, no business credit history, and new business owners because the eligibility requirements are less strict when evaluating creditworthiness, business revenue, and net income. Borrowers may be eligible for larger loan amounts or longer repayment terms when applying for an ABL.

Improved liquidity.

Using asset-based lending allows small business owners to improve their liquidity and achieve financial stability. For business plans where revenues or working capital fluctuate based on seasons or growth and expansion strategies, an ABL improves monthly cash flow.

Lower interest rates

Secured loan options typically offer borrowers a lower interest rate than traditional loans, even for borrowers with good credit. This is because the collateral used to secure the ABL decreases the risk for the lender, which lowers the interest rate and total financing costs to the borrower.

Fewer covenants

Asset-based lending agreements contain fewer covenants than unsecured loan agreements because managing the terms of the loan is simplified when monthly payments are guaranteed by the asset.

Disadvantages of asset-based loans for business

While asset-based loans are a great financing option for many small business owners, there are disadvantages to these types of loans to consider before beginning the application process.

Choosing the right type of asset

It’s already been stated that lenders prefer liquid assets that can easily be converted to cash in the case of the borrower’s default. This means that an asset-based lender may not accept a physical asset, like real estate. During the underwriting process, the lender will request an appraisal of your valuable asset that will determine its total market value and the liquidity of the asset.

The risk of losing the asset

There are major risks in using liquid assets, like savings accounts, or physical assets, like real estate, to secure a loan. If you cannot repay the loan, the lender will seize your asset. This may mean giving up your family home or company assets if your business can’t make the monthly payments on the ABL.

Borrowing limits

Asset-based financing options tie the value of the asset used as collateral to the total approved loan amount. Some ABLs will only approve a loan at a certain percentage of the asset value, like when a mortgage can only be secured for 70 to 90 percent of the real estate cost.

Future financing opportunities

Secured business loan activity is reported to the major credit bureaus by traditional lenders or alternative lenders, so the loan and payment history will appear on the small business credit report. Choosing an ABL for your business may mean that you will have to explain to an investor or lender in the future why your business was required to pledge collateral.

How to find asset-based financing for your small business

Finding asset-based financing is easy and taking the appropriate steps will ensure that you connect with the right lender and the correct type of business loan option. Before applying for a secured loan, you may want to explore other business financing options, like SBA loans or unsecured lines of credit, with the lender you’ve chosen. There is no harm in checking several loan offers before accepting any funding.

Find the right lender

Traditional financial institutions, like national banks, offer secured loan options. Alternative lenders, like Biz2Credit, also help their customers secure asset-based loans. To find the right lender, talk to other professionals in your industry or browse the web and read customer reviews. You can learn a lot about a lender by checking out the FAQs on their website.

Gather your documents

The documents you will need to apply for a small business loan will vary depending on the lender, the type of loan, the total loan amount, and your creditworthiness. Preparing the following standard loan documents ahead of time will speed up the loan application and approval process.

  • Proof of identification, like a driver’s license
  • Business organizational documents, including the most recent annual report
  • Business financial reports, like the balance sheet, budget, and income statement
  • Business and personal credit reports
  • Accounts receivable ledgers
  • Business banking information
  • Deed or proof of ownership for collateral
  • Appraisals of asset

Apply for financing

Working with an online lender is a fast way to get access to your borrowed funds. Online lenders usually offer an easy online application that you can complete in a few minutes. Once the application is submitted, a business lending expert will contact you to request any further details and explain how you will be able to review your funding options. Before filling out your application be sure you know how much money you are seeking and what purpose you will be using your funds. How you will use the loan proceeds will help determine the approval amount and help the lender show you the best loan options for your financial situation and business needs.

Review your funding options

Once the lender has reviewed your loan application, you may receive several loan options. Take some time to review the loan offers carefully and ask your lender if you have any questions. The keys to choosing the right funding are to consider:

  • How will the monthly payment impact your business’s operations?
  • Are comfortable using a business asset as collateral?
  • Does the loan amount help you achieve your business goals?

Bottom Line

Asset-based loans are a great financing option for large business expenditures and small business owners that may not qualify for unsecured loan options. A secured line of credit opened many doors for this medical transcription company from New Jersey, and a similar funding option could help you meet business needs. Before applying for an ABL, consider the risks of pledging collateral as well as the impact of the loan on the future of your business. If you’re ready to secure your financing, contact Biz2Credit to review multiple loan options in one stop.

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