What is asset-based lending?
Asset-based lending can be defined as working capital financing secured by a business’ current assets (receivables and inventory). As most wholesale-type and service-related businesses have to offer credit terms to their customers to remain competitive, asset based loans are used primarily as a bridge to cover these cash flow gaps.
What is factoring?
Factoring is the outright purchase of accounts receivable at a discount for cash, with or without recourse (without recourse means that the factor assumes the credit risk of non-payment by the client’s customers). However, most factoring companies only provide factoring services on a full recourse basis, meaning the customer is liable for account debtor non-payment anyway. A factoring company typically handles all of a customer’s back-office work (primarily credit and collection services), though the cost of this is typically very high. Most factoring services are offered by non-bank finance companies.
What are the differences between asset-based and factoring lending?
Typically, asset-based lending is not as intrusive into a borrower’s business as factoring is. Also, asset-based lending can be offered at a significant discount (as much as half) and involves only select back-office work as opposed to daily meddling.
What are the advantages of asset-based lending?
Asset-based lending allows companies to (a) take advantage of early pay discounts with vendors, (b) make payroll or hire additional employees, (c) acquire additional inventory to generate additional sales, and (d) offer credit terms to their customers. An additional advantage is that by using A/R and inventory as collateral, borrowers don’t need to offer real estate, equipment, or other business assets as collateral. In addition, asset-based lending can offer better advance rates than are available through “conventional” lines of credit at local or regional banks.
What kind of company would be a good candidate for asset-based lending?
A company is a good candidate if it sells to commercial concerns on terms of open credit or is experiencing or has experienced any of the following:
Erratic or marginal profitability or recent losses
Cash flow shortages
Long shipping cycles or seasonal working capital shortages
Lack of historical financial information (early stage businesses)
Are there companies in specific industries that could benefit from asset-based lending? While asset-based lending isn’t limited to companies within specific industries, these industries are particularly well-suited;
Service-oriented businesses such as staffing, IT consulting, or janitorial
Wholesale apparel industry
Trucking and transportation
The common theme among these industries is companies with a good customer base that is required to wait for their customer to pay for goods or services.
What’s an example of a small business with a “good” customer base?
Consider this scenario: A start-up apparel company sells its products to companies as established as Wal-Mart, Costco, and Target. As well as smaller, local stores. Many traditional banks would turn this client down for a loan because the company doesn’t have an established credit history. However, this business could be a good candidate for an asset-based loan because its customers have established credit histories. Also, the business has a diverse client base, which means that it isn’t relying on one customer for the majority of its receivables.
What are the costs associated with asset-based lending?
Costs will vary depending on the business’ specific situation. However, it is fair to say that the cost difference between a factoring loan vs. an asset-based loan can be substantial. In many cases, the asset-based loan expenses are a third or even half the amount of factoring-based loan expenses.
Why don’t most conventional banking institutions offer asset-based lending?
The concept of asset-based lending is contrary to the typical mindset of traditional banks, which is focused on an established and stable history of operational and financial performance. Also, many conventional banks lack the experience and expertise required to properly manage the day-to-day maintenance of asset-based lending.