Business owners know that applying for traditional financing can be challenging. Banks and credit unions are more strict than alternative lenders when lending to small businesses because of their risky nature. Unless the business can prove that they have a solid track record of cash flow and have enough experience in the industry, their chances of getting approved for traditional financing is low.
Fortunately, for businesses that don’t qualify for traditional loans, asset-based financing could be a viable alternative. This article will outline everything you need to know about asset-based financing, including what an asset-based loan is, the two types, and how you can use asset-based loans.
What is an Asset-Based Loan?
As the name implies, an asset-based loan is a type of financing secured by collateral. The collateral could be a tangible and intangible asset with a significant value. The assets will serve as a safety cushion for lenders so that in the even the business defaults, the lenders can use the asset as payment.
Asset-based loans typically look at the business's cash flow and credit before collateral. In an asset-backed loan, they look at the collateral first before then the company’s cash flow.
Companies with several assets in their possession can use an asset-based loan to get the capital they need for their business operation. With the extra money, businesses can invest in business opportunities such as product or business expansion, pay for operating and overhead expenses, or purchase supplies and inventory.
Considerable Assets For Asset-Based Loan
The type of acceptable assets will depend on the lender and the type of loan you’re applying for. In general, the most common assets used in asset-based lending include:
- Invoices or accounts receivable
- Purchase orders
- Equipment or machinery
- Real estate
- Intellectual property
Two Types of Asset-Based Loans
Asset-based loans come in two types: asset-based term loans and asset-based lines of credit. Here’s how each of them works:
1. Asset-Based Term Loans
A business term loan is a traditional type of business financing wherein the financing company gives borrowers a lump sum, which can be repaid within a set amount of time. With that definition, an asset-based term loan is a financing structured as a regular term loan that is backed up with collateral.
Once the business owners settle the loan amount and pay the loan in full, they may not be able to apply for another asset-based term loan for a while. In this case, they would have to apply for other types of business financing to address their business needs.
2. Asset-Based Line of Credit
Like asset-based term loans, an asset-based line of credit is also a type of financing backed up by collateral. But unlike an asset-based term loan, a line of credit is a type of revolving credit. This means that the business can access it repeatedly as long as they don’t exceed the set credit limit.
One benefit of an asset-based line of credit is that you’ll only have to repay the amount of money you took out plus the interest. Once the business pays the amount in full, the credit line returns to its original amount, and the company can again draw from it if the need calls for it.
Most Common Uses for Asset-based Loans
The good thing about asset-based financing is that it provides business owners with flexibility. They can use it for any business-related needs. Here are some ways they can utilize and maximize an asset-based loan:
1. Safety cushion during the slow season
Seasonal businesses often experience cash flow issues during the slower seasons. This makes it harder for them to operate their business during those months. However, with asset-based lending, the company will have enough cash to meet payroll, pay for day-to-day expenses, and restock inventory.
Once the peak seasons are back, the business can earn more profit and use a portion of their sales to pay back the loan.
2. Business growth and expansion
Businesses have to take advantage of business opportunities to get ahead of their competitors give their company a chance to grow and expand. But to do that, you’d need additional capital. If you have assets listed in your business, you could use that to obtain funding. With the extra cash, you can pay for marketing strategies, hire more employees, open another brand, or expand your product line. Asset-based lending can give you the capital you need for sustainable growth.
3. Equipment purchases
Business equipment can be expensive. But they also play a vital role in streamlining your business operations.
If you need to purchase or lease a piece of equipment, but can’t afford the upfront costs, an asset-based loan like equipment financing could help. This financing ties up the borrowed amount to the equipment purchased. This adds security on the lenders' part because if the business defaults, they can take the equipment to pay for the remaining loan balance.
If you ever find yourself in a cash crunch and have some business assets to spare, asset-based financing can be a viable financing option for your business. With one, you can resolve seasonal cash flow crunches, purchase necessary equipment, add more employees, and expand your business operations.
However, before applying for one, be sure that you know what asset-based lending is and how it works. This way, you’ll have a better sense of how you can maximize the benefit that the financing offers.