Securing the right funding for your small business is crucial for growth and stability. Asset-based lending is one option for financing for businesses that have strong assets and need access to working capital. But is asset-based lending the right choice for your small business? Below we go over the pros and cons of this approach to help you make an informed decision.
What Is Asset-Based Lending?
Asset-based lending (ABL) is a type of business loan that is secured by using a company’s assets as collateral. These assets can include a variety of tangible and intangible items that have value, such as inventory, accounts receivable, equipment, or real estate.
Asset-based financing can be easier to qualify for compared to other small-business loan options. However, if the borrower defaults on the loan, the lender can seize and sell the assets to recover their money.
The Process of Asset-Based Lending
In order to better understand your business’s financial health, your lender will first evaluate your business’s financial information, including its assets, financial statements, and credit history. Next, based on a thorough asset evaluation, your lender will offer a loan amount. This amount is typically a percentage of the value of the collateral, known as the “advance rate”. Generally, liquid collateral such as certificates of deposit or securities are more valuable to a lender because they can be easily converted to cash if you default on your loan. Finally, your lender will also establish the terms of the loan, including the interest rate, repayment schedule, and any associated fees.
Pros and Cons of Asset-Based Lending
Pros
- Access to quick capital. A primary advantage of asset-based lending is that it’s typically a quicker process than traditional loan approval. If your business needs funds urgently, such as covering unexpected expenses, this can be a significant advantage.
- Flexible terms. Because the loan is secured by business assets, this type of lending could be a better fit for businesses that don’t meet the strict criteria of conventional loans. Asset-based lending offers more flexibility than traditional loans, which can be beneficial for businesses that have a shorter credit history or imperfect credit scores.
- Lower interest rates. Because the collateral you provide reduces the lender’s risk, you’ll typically receive lower interest rates on asset-based loans compared to unsecured business loan options.
- Flexible financing. Funds from asset-based loans aren’t typically restricted. They can be used for various purposes, such as financing growth initiatives, covering operational expenses, or managing cash flow gaps.
Cons
- Risk of losing assets. If your business fails to repay the loan, your lender can seize and sell your business assets to repay the debt. If the assets you used as collateral hold strategic importance for your business operations, losing them could have adverse effects on your business.
- A thorough and time-consuming process. A lender’s assessment of your assets can be time-consuming and may require professional appraisals, audits, and legal documentation. Furthermore, some of your business assets may not qualify for an asset-based loan. Lenders generally prefer tangible and sufficient assets, so items such as specialized goods, perishable inventory, and equipment with high depreciation rates typically aren’t accepted as collateral.
- Costs and fees. While asset-based lending often comes with lower interest rates than other financing options, it’s important to consider other associated costs. Lenders can charge origination fees, appraisal fees, and ongoing monitoring fees, all of which can impact the overall cost of the loan.
Asset-based lending can be an effective tool for small businesses seeking access to capital, but the decision to pursue this type of lending should be made after careful consideration of your business’s assets, financial needs, and risk tolerance.
