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When to Use Asset-Based Lending

By Barbara Beauregard   |    September 4, 2015   |    9:17 AM

Struggling to figure out how to finance your small business? Consider trying asset-based lending to get the job done. In simplest terms, asset-based loans are just what they sound like—business loans that are based on the tangible physical assets of your small business. This usually means accounts receivable and inventory but can sometimes include less obvious items, such as company vehicles. It’s a pretty simple proposition, but it is important to understand the advantages, challenges and risks of asset-based loans. You are risking your future revenue in order to gain access to more funds today.

Asset-based lending institutions will generally loan a small business funds based on a percentage of the value of your small business assets. The industry standard is about 70 to 80 percent of qualified receivables and 50 percent of finished inventory and/or supplies.

Asset-based loans are one of the most widely available lending platforms in the United States and the companies and lenders that offer asset-based loans are quite diverse, ranging from banks to credit unions to independent financial institutions. For small businesses, the tricky part is finding lenders that are willing to offer asset-based loans to new or fledgling companies. Many asset-based lenders prefer to make larger loans because the cost, personnel and time involved to screen and monitor asset-based loans

Banks are looking for some common characteristics in the small businesses to which they loan funds based on assets. Your small business should have good financial statements, a sound set of reporting systems, solid inventory records and ultimately, customers who pay their bills on time. The ideal situation is to come to the lender with solid financial information that reflects the day-to-day realities of managing and running your business. This data is key to making your lender confident that your small business has long-term viability and that you have a full and complete understanding of your small business and its assets.

There are many advantages to asset-based loans for small businesses, especially if your small business is experiencing growth or some other kind of tension. At times, a small business may need the shot in the arm that an influx of cash can provide in order to get over a financial burden, prevent undercapitalization, or keep growth from stagnating. These types of asset-based loans are particularly well-suited for manufacturers (which by their nature carry a great deal of physical assets) as well as distributors and service companies whose seasonal sales often hamper cash flow in the quieter months. Asset-based loans can also be used to finance acquisitions, obtain equipment, or staff up to encourage growth.

However, owners of small businesses are forewarned that there are potential risks and downsides to pursuing asset-based loans from a bank or other financial institution. Your chances of securing a credit line based on your assets are—no surprise here—only as good as the quality of your assets. Lenders will quickly identify customers that pay quickly, usually in less than 60 days. They may also not consider sales to individuals or other small businesses as suitable receivables.

These types of small business loans also cost more than traditional forms of credit. Interest rates for asset-based loans can vary to a wide degree, and banks may also impose additional fees to cover their costs in processing and monitoring your loan. In a worst-case scenario, large lending institutions may also require your personal guarantee, which potentially puts your personal assets at risk during the transaction. In some cases, the backers of your asset-based loan may require that your customers send payments directly to their finance company. This can be restrictive to the control and growth of your business because a third party now has control of your cash flow to some degree.

So consider your options closely before seeking out asset-based lending but don’t rule it out. In years past, asset-based loans were often seen as a “last resort” for troubled businesses. But as venture capital and governmental loans have been taxed in recent years, asset-based loans are widely seen by the small business community as a highly-regarded and easy-to-implement form of lending that can benefit many small businesses to a high degree.

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