Understanding Asset-Based Lending and Its Benefits for Your Business
How does asset-based lending vary from traditional bank loans?
Even though a business generates significant assets it may still experience cash shortages. It may grow so rapidly that the company’s cash flow is not aligned with traditional borrowing requirements. Or the business may already have a line of credit from a bank but is unable to secure additional funds from them. In situations like these, there’s a way for companies to let their assets work even harder and provide a beneficial liquidity boost.
For a business looking to fund its working capital needs — smoothing seasonal cash flow fluctuations, pursuing growth opportunities or financing higher leverage or debt positions — asset-based lending may be the right choice. Asset-based lending is a flexible approach to financing a business’s current operations and needs for future growth. It may provide more favorable financing than traditional loans, likely with faster processing times and more competitive pricing and terms.
However, there are essential differences between asset-based lending and traditional bank loans, and much to consider when thinking about applying for an asset-based business loan.
What is asset-based lending?
The primary difference between asset-based lending and traditional bank lending is what the lender looks at when underwriting a loan. A traditional lender looks first at the historical profitability and cash flow of a business, then to its collateral while an asset-based lender primarily looks to a company’s collateral position.
Asset-based lending is a form of lending (lines of credit) with an emphasis on the short-term assets of the borrower’s balance sheet. Advances are made on the company’s assets such as accounts receivable, inventory and possibly equipment.
The loans are governed by a “borrowing base” of agreed upon advance rates on the assets along with covenants based upon the company’s expectations in the form of projections. By focusing more on the underlying collections from the borrower’s customers, the asset-based lender oftentimes can provide higher advance rates (i.e., on the eligible accounts receivables and inventory) than what may otherwise be available through traditional bank sources.
How does asset-based lending work?
In traditional or conventional bank lending, a company’s creditworthiness, profitability and cash flow is relied upon for bank approval. Asset-based lenders instead rely on the creditworthiness of the borrower’s customers and their payment history to determine the borrower’s creditworthiness.
Companies which tend to have a reliable cash conversion cycle—from cash to inventory purchases, to accounts receivable and back to cash—may be particularly attractive for an asset-based lender.
Benefits to the borrower
Asset-based loans can be more favorable, which means some or all the terms are often more competitive, including lower interest rates and less stringent restrictions, repayment schedules and covenant structures.
Oftentimes asset-based loans may be approved faster and funded more quickly than traditional bank loans. Since longer-term assets (i.e., real estate and intangibles) are typically outside of asset-based credit facilities, the closing process tends to be quicker as there is no need for appraisals.
The terms and structure may be more attractive to the borrower as the loans typically do not require a fixed repayment schedule but are more flexible and based upon the company’s overall cash flow. Since the asset-based credit facility is based on the borrowing-base of short-term assets, the credit availability would expand for growth situations, mergers or acquisitions. Asset-based lending is also a preferred solution for seasonal companies as its borrowing base expands or contracts together with its overall borrowing needs.
By utilizing a bank’s lower cost of funds and its technology platforms, asset-based lending may also be a competitively priced alternative to other sources of capital. As companies maintain deposits and use other bank products and services, the asset-based credit facilities may be priced at or near traditional bank rates.
From an industry perspective, asset-based loans are an appropriate fit for a variety of industries, such as manufacturers, distributors and service companies, which are looking to finance its growth, acquisitions or even dividend distributions.
Choosing a lender
Many banking institutions offer in asset-based lending. They help companies finance their operating capital shortfalls, such as inventory purchases, payroll and other operating expenses or support growth with much-needed funding. It is important to work with a lender that specializes in asset-based lending and can cater to unique business needs and requirements. Key criteria for selecting a lender include overall credit availability, the terms and conditions and the interest rate. Even if you have a prior relationship with a specific lender, it’s worth exploring the market for alternative options.
Since asset-based lending relies on asset quality, this type of financing is especially beneficial when a company is experiencing significant growth, seasonality or has other urgent cash needs. This could be a business with seasonal peaks and fluctuating cash flow, or a company looking for capital needed to grow.
Whatever the reason, asset-backed loans can often be a more flexible and competitively priced financing option for asset-rich businesses.
Torrey Pines Bank's Capital Finance Group is committed to the success of its clients in both good and challenging times, helping them use their assets to their full potential. We help clients maximize their borrowing capacity to deliver the liquidity they need for both operations and growth with our asset-based lending.