What Is Asset-Based Lending?
Asset-based lending is the business of loaning money in an agreement that is secured by collateral. An asset-based loan or line of credit may be secured by inventory, accounts receivable, equipment,or other property owned by the borrower.
The asset-based lending industry serves business, not consumers. It is also known as asset-based financing.
Key Takeaways
- Asset-based lending involves loaning money using the borrower's assets as collateral.
- Liquid collateral is preferred as opposed to illiquid or physical assets such as equipment.
- Asset-based lending is often used by small to mid-sized businesses in order to cover short-term cash flow demands.
How Asset-Based Lending Works
Many businesses need to take out loans or obtain lines of credit to meet routine cash flow demands. For example, a business might obtain a line of credit to make sure it can cover its payroll expenses even if there's a brief delay in payments it expects to receive.
If the company seeking the loan cannot show enough cash flow or cash assets to cover a loan, the lender may offer to approve the loan with its physical assets as collateral. For example, a new restaurant might be able to obtain a loan only by using its equipment as collateral. Lenders might require a negative pledge clause or covenant as part of the loan. This clause will limit the borrower from reusing the pledged asset for another loan.
The terms and conditions of an asset-based loan dependon the type and value of the assets offered as security. Lenders prefer highly liquid collateral, such as securities, that can readily be converted to cash if the borrower defaults on the payments. Loans using physical assets are considered riskier, so the maximum loan will be considerably less than the book value of the assets. Interest rates charged vary widely, depending on the applicant's credit history, cash flow, and length of time doing business.
Interest rates on asset-based lending are lower than rates on unsecured loans since the lender can recoup most or all of its losses in the event that the borrower defaults.
Example
For example, say a company seeks a $200,000 loan to expand its operations. If the company pledges the highly liquid marketable securities on its balance sheet as collateral, the lender may grant a loan equalling 85% of the face value of the securities. If the firm’s securities are valued at $200,000, the lender will be willing to loan $170,000. If the company chooses to pledge less liquid assets, such as real estate or equipment, it may only be offered50% of its required financing, or $100,000.
In both cases, the discount represents the costs of converting the collateral to cash and its potential loss in market value.
Special Considerations
Small and mid-sized companies that are stable and that have physical assets of value are the most common asset-based borrowers.
However, even large corporations may occasionally seek asset-based loans to cover short-term needs. The cost and long lead time of issuing additional shares or bonds in the capital markets may be too high. The cash demand may be extremely time-sensitive, such as in the case of a major acquisition or an unexpected equipment purchase.
FAQs
Asset-based lending is the business of loaning money in an agreement that is secured by collateral. An asset-based loan or line of credit may be secured by inventory, accounts receivable, equipment, or other property owned by the borrower. The asset-based lending industry serves business, not consumers.
What is an example of asset backed lending? ›
Asset-based lending example
Your lender agrees to offer a loan equal to 85% of the value of your marketable securities. If your marketable securities have a value of $120,000, the lender can provide a maximum loan amount of $102,000.
Which of the following is an example of a form of asset-based lending? ›
Asset-based lending refers to a loan that is secured by an asset. Examples of assets that can be used to secure a loan include accounts receivable, inventory, marketable securities, and property, plant, and equipment (PP&E).
What is an example of a loan asset? ›
An example of a loan asset is real estate. You can use your property, like a home or commercial building as collateral for a loan. The lender evaluates the property's value and extends a loan based on a percentage of that value.
What are the disadvantages of asset-based lending? ›
Risk of losing valuable assets
In the event the business fails to repay the loan, the lender can seize the asset that was pledged as collateral to secure the loan or line of credit. The collateral may be sold by the lender to recover the money that was issued to the borrower.
How does asset-based lending work? ›
With ABL, a lender will instead focus primarily on the value of your business's assets, which are used as collateral to secure a loan. First on the list is accounts receivable; typically, only current receivables (those that are less than 90 days from invoice date or no more than 60 days past due) are considered.
What are the types of asset-based loan? ›
The four main types of asset-based loans are Accounts Receivable Financing, Inventory Financing, Equipment Loans, and Real Estate Loans.
What are the risks of asset-backed lending? ›
Risks of Asset Based Lending
If you put up an important revenue-producing asset as collateral, failing to pay back the loan could result in the loss of that critical asset. This is the greatest risk in this type of financing.
Is asset-based lending the same as borrowing base? ›
Asset-based loans, like many cash flow loans, are often structured as revolving loans. In asset-based lending, the lender typically lends up to an agreed percentage of the value of the specific assets (called a borrowing base).
What is the interest rate for asset-based lending? ›
In general, asset-based loan rates range from 5.25% to 15%.
The borrower will make payments to the lender to pay off the asset over time. At such time, the asset is owned by the lender until the loan is paid off. Once the final payment is made, the borrower will be given the option to purchase the asset at a nominal rate.
What is the difference between asset-based lending and asset financing? ›
Asset financing lets a business borrow money to purchase assets, while asset-based lending is when a company borrows money and uses what it already owns to guarantee payment. Both facilities help businesses expand and grow in operations, allowing them to increase their production capabilities.
What type of loan is considered an asset? ›
Simply put, an asset is something of value that you own or that is owed to you. If you lend money to someone, that loan is also an asset because you are due that amount. For the person who owes the money, the loan is a liability.
What is a loan that is linked to an asset called? ›
An asset-based loan or line of credit may be secured by inventory, accounts receivable, equipment, or other property owned by the borrower. The asset-based lending industry serves business, not consumers. It is also known as asset-based financing.
Do banks consider loans an asset? ›
Loans, such as mortgages, are an important asset for banks because they generate revenue from the interest that the customer pays on the loan.
What is a loan that is not linked to an asset called? ›
Unsecured loans do not involve collateral specifically; however, the lender may have a general claim on the company's assets if repayment is not made. If the company goes bankrupt, secured creditors typically receive a greater proportion of their claims.
What is an example of asset-backed securitization? ›
Asset-backed securities (ABSs) are financial securities backed by income-generating assets such as credit card receivables, home equity loans, student loans, and auto loans.
What are three major types of asset backed securities? ›
ABS Collateral Examples
Some common examples of asset backed securities (ABS) include: Home Equity Loans. Auto Loans. Credit Card Receivables.
What is a loan that is backed by an asset? ›
Asset-based lending is a business financing method that uses an asset owned by a business as security against a business loan. The lenders evaluate assets such as inventory, accounts receivable, property, or industrial equipment to determine whether a business is eligible for finance.
What is the difference between asset-backed loans and mortgages? ›
The Bottom Line. Asset-backed securities represent ownership in diverse pools of assets like auto loans and credit card receivables. In contrast, Mortgage-backed securities specifically involve ownership in pools of mortgage loans with the cash flows derived from homeowners' mortgage payments.
