This article contains general information and is not intended to provide information that is specific to American Express, or its products and services. Similar products and services offered by different companies will have different features and you should always read about product details before acquiring any financial product.
How Does Asset-Based Lending Work?
Asset-based lending is a type of financing that requires companies to use their assets as collateral — like how people use a home as collateral for a mortgage.
Business owners can pledge various types of assets as collateral so long as a lender will accept them. They may also be able to combine assets to increase their borrowing power. Eligible assets could include:
- Inventory
- Equipment
- Real estate
- Accounts receivable
- Cash and securities
- Intellectual property
With an asset-based loan or line of credit, lenders could choose to focus on the value of the company’s assets more than their cash flow when determining financing amounts and terms.
Example of Asset-based Financing
Consider a toy manufacturer that’s gearing up for a busy holiday season. As summer gives way to fall, it needs to buy supplies and hire temporary staff to fulfill incoming orders. But it doesn’t have much cash and won’t collect payments for the orders until the end of the year.
The manufacturer could consider using its accounts receivable or facilities as collateral for ABL and open a line of credit. If approved, it could take a loan – also referred to as a draw — from their line of credit that could help cover immediate expenses.
Why Choose Asset-Based Lending?
Traditional banks and non-bank commercial lenders may offer ABL. There could be downsides to this source of business funding, including the cost of financing and the risk of losing the assets. However, ABL might be a good fit for certain types of businesses.
Pros and Cons of Asset-Based Lending
The specifics for ABL will vary from one lender to the next. But here are some general pros and cons to consider.
Pros of asset-based lending
Some of the advantages of ABL include:
- Funds when you need them: ABL may offer a relatively quick and easy application and funding process. Companies may also be able to use the funds for almost any business purpose.
- Approval is often based on the assets themselves: Because ABL largely depends on the asset’s value and quality, companies with low margins or a short credit history may have an easier time getting approved for ABL than other types of financing.
- More flexibility: ABL may offer more flexibility than some other types of financing because the credit limit may be linked to the current value of the assets.
Cons of asset-based lending
Here are some potential downsides of ABL to weigh:
- Not all assets will be accepted as collateral: Lenders might not accept certain types of assets as collateral, including past-due receivables, branded inventory, specialized equipment, or real estate. In short, the lender is likely looking for assets that they could sell quickly so they could receive the amount they are owed.
- Assets may be undervalued: Lenders typically only extend a portion of the asset’s value depending on the type of asset, how easy it is to liquidate, and an inspection or appraisal of the asset. For instance, a company might be able to borrow up to 85% of the value of its accounts receivable, but only 60% of its inventory’s value.
- Chance of losing assets: Because the assets are collateral, they are at risk if the borrower defaults on the loan.
Asset-Based Lending Could be an Option for Your Business
Asset-based lending could be a good fit for companies that have valuable assets and need cash quickly – it could help small business owners address potential gaps in their cash flow or struggles to expand. Other factors to consider with ABL include how the costs and terms compare with other types of financing.
The material made available for you on this website is for informational purposes only and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.
