Asset-based lending is a term that describes an extension of credit secured by the tangible assets listed on a business’ balance sheet. That business may be a sole proprietorship, partnership or corporation. Asset-based lending is the equivalent of a secured loan in the consumer world, with one major difference; a consumer would not be able to persuade a bank to lend money secured by his best friend’s or his workplace colleague’s I.O.U. However, businesses can do that, well—sort of! Let me explain.
Asset-based loans, by definition, are loans secured by the tangible assets of a business entity as reflected on the company’s balance sheet. These loans are usually made for inventory acquisition, raw materials to produce inventory, bridging cash flow shortfalls and other sound business reasons. It is easier for businesses to receive these types of loans because they are secured, and represent less risk to the lender. Following the same logic, interest costs are also lower than interest rates would be for an unsecured extension of credit … if the business could even qualify for unsecured credit!
Please, don’t interpret this to mean that any business with tangible assets is automatically qualified for a loan. The 5 Cs of credit still apply; character, collateral, capacity, capital and conditions, although in many cases, the credit worthiness of the business is not a major concern.
Since the financial crisis, banks have been squeezing their pennies so tightly that if you listen closely, you can hear Lincoln scream. For this reason, asset-based alternative lenders have seen a surge in the demand for their offerings.
What Assets are You Talking About
As mentioned earlier, virtually any tangible asset can be used to secure a loan from an asset-based lender. The most frequently used asset is a company’s accounts receivable. Accounts receivable are basically like an I.O.U.s from customers, agreeing to pay a specific amount, in an agreed to number of days, for goods or services provided by the business. Through invoice financing, a company can submit unpaid invoices to a factor in exchange for an immediate cash advance. This does not appear on a company’s balance sheet as a loan (liability), which coupled with the ready cash provided, is an attractive option for many small to medium size concerns.
Asset-based lending might also include loans secured by inventory, patent rights, short or long term investments, inventory and the company’s real property and equipment.
Shedding the Negative Image
In some respects, it is fair to compare asset-based and alternative lenders to a SWAT team. They appear to be a largely superfluous, perhaps even a dark or menacing force … until you are taken hostage in a bank holdup! However, once you encounter a problem, they are suddenly extremely important, and maybe even your best friends forever! Asset-based and alternative lenders are similar in today’s lending environment. Who you gonna call? The banks aren’t lending, especially to small and medium sized business.
The current capital needs of business have been the driving force behind the evaporation of the negative image once shouldered by asset-based lenders. Because they have answered the 911 call the bad rap is found to be uncalled for. Asset-based lenders have resolved many of small and medium sized businesses’ financial problems. In short, many companies have found a new best friend.
There has never been a valid reason for the negative image suffered by factoring firms, invoice financing companies and other asset-based lenders. The difference between a rainforest and a jungle is that the rainforest has a public relations office.
Who are the Beneficiaries of Asset-Based Lending?
Those benefitting from asset-based lending extend well beyond the lender and the business. Employees of both lender and borrower benefit because they retain their jobs. Other businesses benefit indirectly from the purchasing power of those working employees who buy goods and services. Government—state, local and federal, benefits from tax revenues derived from the business and the employees of those businesses.
Capital is like a stone thrown in a pond. The water’s ripples are always widening and so it is with money. There is an excellent article (I can say that because I wrote it) you might consider reading that provides greater insight. It is titled, “Factoring—a Positive Force for Social Good.”
Asset-based lending is enjoying a vigorous resurgence in popularity with small to medium sized companies, not only because the universe of options has diminished, but also because the creditworthiness of the business is not of paramount concern to the asset-based lending community. This is not to suggest that there aren’t standards to meet … there are, but happily not nearly as stringent as your friendly banker’s. Furthermore, a business can demonstrate its qualifications far more easily with an asset-based lender. The red-tape exists, but it is minimal when contrasted with the reams of documentation a company might have to provide a conventional lender.