CASH FLOW - What is asset-based lending?

Asset-based lending (ABL) is when a lender issues you a loan that is secured by some form of collateral, such as inventory, accounts receivable, equipment or real estate, among other business assets.

Because this collateral reduces risk for the lender, asset-based financing can be easier to qualify for compared to other small business loan options. However, if you default on your loan, your lender can seize and sell your assets to recover losses.

How does asset-based lending work?

Both traditional and online lenders offer asset-based financing. These products can be structured as term loans or lines of credit.

In either case, your lender will make you a loan offer based on the type and value of your available collateral in addition to your other qualifications. To determine the amount of funding you’re eligible to receive, lenders will typically use the loan-to-value ratio (LTV).

LTV is calculated by dividing the loan amount by the value of the asset you’re putting up as collateral. If you’re using your inventory as collateral, for example, your lender may only be willing to offer a loan of up to 50% of the value of your inventory.

In general, the more liquid your collateral, the more likely you are to receive higher funding amounts and lower business loan rates.

Lenders prefer you to put up highly liquid collateral — such as certificates of deposit or securities — because it can be easily converted to cash if you default on your loan. On the other hand, physical assets are considered more of a risk.

Asset-based lending example

Let’s say your business is looking for a $100,000 loan to grow your operations. You apply for financing from an asset-based lender and plan to secure your loan with marketable securities (e.g., stocks, bonds, preferred shares).

Your lender agrees to offer a loan equal to 85% of the value of your marketable securities. If your marketable securities have a value of $120,000, the lender can provide a maximum loan amount of $102,000.

If, however, you wanted to secure your loan with inventory, the lender may only offer 50% of the value of that collateral. In this scenario, even if your inventory was worth $120,000, your maximum loan amount would fall to $60,000. That's $40,000 less than what you’re looking to get.

Pros and cons of asset-based lending

Pros

• Can be easier to qualify. With asset-based lending, the lender focuses mainly on the value of your collateral when evaluating your loan application. If you have strong assets to offer, you may still be able to access financing even if you have unstable cash flow or a rocky credit history.
• Competitive interest rates. Because your collateral mitigates risk for the lender, you’ll likely receive lower interest rates on an asset-based loan compared to unsecured business loan options.
• Flexible financing. Asset-based loans can be used for a variety of purposes, including managing cash flow gaps, covering operating expenses and investing in new opportunities. Asset-based lenders don’t typically restrict your use of funds, making these loans a good option for a range of different small businesses.

Cons

• Certain assets may not qualify as collateral. Some of your business assets may not be eligible collateral for an asset-based loan — ultimately, your lender will make this determination. For instance, lenders may turn down specialized goods, perishable inventory or equipment with a high depreciation rate.
• Additional fees. Although these products may have lower interest rates than other financing options, additional fees can drive up loan costs. You may have to pay fees associated with evaluating and monitoring your collateral, such as origination audit and due diligence fees.
• Putting your assets at risk. If you default on your loan, your lender can claim and sell your business assets to repay the debt and recoup its losses.