What Are Asset-Based Loans and How Do They Work?

Disclaimer: Information in the term loan articles is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the term loan articles often covers financial products that Biz2Credit does not currently offer.

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. If the borrower defaults, the financial institution seizes 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 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 or residential real estate
• Equipment or 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
• Jewels, antiques, or vehicles

Each lender will consider collateral differently, so be sure to check the disclosures to see what the bank will accept as an asset.

Types of Asset-Based 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 business 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 term loan 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 Financing

ABLs provide an alternative financing option to traditional bank loans, unsecured lines of credit, and government-backed funding programs, like SBA loans. Here are a few of the benefits of asset-based lending.

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. Borrowers may be eligible for larger loan amounts or longer repayment terms when applying for an ABL, making an asset-based loan a flexible financing option.

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.

Higher Borrowing Capacity

Asset-based loans allow for potentially larger loan amounts because of the loan being secured.

Disadvantages of Asset-Based Loans

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 asset that will determine its total market value and the liquidity of the asset.

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 assets. 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 a small business credit report.

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 revolving 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 commercial banks, offer secured loan options. Alternative lenders also help their customers secure asset-based loans, and potentially give credit approval to those who wouldn’t normally qualify.

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.

• Business financial reports, like the balance sheet, budget, and income statement
• Business and personal credit reports
• Accounts receivable and accounts payable ledgers
• Business banking information
• Deed or proof of ownership for collateral
• Appraisals of secured asset

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. Before applying for an ABL, consider the risks of pledging collateral as well as other possible financing solutions.

FAQs about Asset Based Lending

What is asset-based lending?

Asset-based business loans are a type of financing where a loan is secured by collateral, such as inventory, accounts receivable, or other assets owned by the borrower. This type of lending is often used by businesses to cover short-term cash flow needs.

Who qualifies for asset-based lending?

Asset-based lending (ABL) is typically available to businesses with valuable collateral, such as accounts receivable, inventory, or equipment, to secure the loan. Companies with stable cash flow, strong assets, and a need for working capital or growth financing often qualify for this type of lending.

What types of assets can be used as collateral in asset-based lending?

In asset-based lending, common types of collateral include accounts receivable, inventory, machinery, equipment, and real estate. Other assets, such as intellectual property or marketable securities, may also be used depending on the lender’s criteria.