Asset-backed lending refers to a business loan or line of credit secured by a business’s assets. Loans back by assets may make sense if your capital is tied up and you’re having trouble getting approved for other types of financing.
Let’s dive deeper into what asset-backed lending is, how it works, and what pros and cons it offers.
Definition and Example of Asset-Backed Lending
In asset-backed lending, a business pledges an asset or assets as collateral in exchange for a loan or line of credit. The loan may be secured by a variety of assets, such as accounts receivable, equipment, inventory, or commercial property.
Let’s say you run a manufacturing business. You need a loan to cover payroll expenses, but you don’t have a lot of cash on hand and find it challenging to get approved for traditional business loans.
After you do some research, you find a lender that offers asset-backed lending to similar businesses in your situation. You decide to move forward with this option and borrow money against your manufacturing equipment. By using your physical assets as collateral, you receive the funds you need.
- Alternate name: Asset-based lending, asset-based loans
- Acronym: ABL
A lender that offers asset-backed lending may not provide funding for specialized assets like custom-made inventory.
How Asset-Backed Lending Works
Asset-based lending can be a loan or line of credit issued by a lender to a business. It can assist with working capital, debt refinancing, seasonal sales fluctuations, mergers, acquisitions, restructurings, and a variety of business needs.
While some lenders require one asset to secure a loan or line of credit, others may consider a combination of multiple assets. The value and quality of your inventory, equipment, or other collateral will determine the amount you’ll be able to borrow. Most lenders will allow you to borrow anywhere from 60% to 90% of your asset’s value.
Lenders typically have a series of requirements for borrowers that go beyond just the assets you provide. In many cases, you’ll need to meet minimums for sales or accounts receivables that might make it difficult for startups to get funding.
If your business has difficulty qualifying for a loan because of bad credit or limited financial history, asset-backed lending can give you the chance to borrow money through your assets. While many types of business may be able benefit from asset-backed lending, this form of financing is widely used by distributors, wholesalers, manufacturers, or those that invest a lot in inventory and accounts receivable.
Asset-based lending is a particularly good option for businesses that are seasonal, growing quickly, trying to meet a production budget, or in the ownership transition phase, and it offers far bigger financing amounts than small business credit cards.
Pros and Cons of Asset-Backed Lending
- Fast approval times
- Flexibility for loan use
- Improved cash flow
- Asset seizure
- Initial costs may be high
- Fast approval times: Compared to traditional bank loans, you can get approved for an asset-based loan fairly quickly.
- Flexibility for loan use: If you take out an asset-based loan, you may use the fund for just about anything.
- Improved cash flow: You'll be able to improve your cash flow and smooth out seasonal peaks and valleys.
- Asset seizure: Per the terms of your loan, your lender can seize the asset you offer for the loan if you default on your payments.
- Initial costs may be high: An asset-based loan’s early fees can cost more than a traditional loan due to origination and administration costs.
Asset-Backed Lending vs. Factoring
Also known as “accounts receivable financing,” factoring is a cash advance on your business’s outstanding invoices. It’s essentially a type of asset-backed lending, because accounts receivable act as collateral and help secure funding from a lender. Unlike asset-backed lending, however, there are no monthly payments with factoring. The lender pays you your invoices in advance, usually subtracting a service fee. When your customers pay their invoice, the payment goes to the lender.
You’ll find that factoring companies usually only offer accounts receivable financing. Therefore, if you want to pledge an asset like equipment or inventory, they won’t be able to help you.
- Asset-backed lending is a business loan or line of credit that is secured by some form of collateral.
- The most common types of collateral used in asset-based lending are equipment, inventory, and accounts receivable.
- It can support businesses in all types of industries with working capital, debt refinancing, seasonal fluctuations, mergers, acquisitions, and restructurings.