It’s almost inevitable that, at some point, your business will need some financing that exceeds your lines of credit. In most cases, this need corresponds with one of those periodic bursts of growth that many businesses experience.
For example, maybe you doubled down on business scaling activities for the last year. All those activities reached a critical mass; now you must fulfill twice the number of orders you did two months ago.
If your business is new or hasn’t breached steady profitability, good luck securing a small business loan, banks prove notoriously conservative about issuing loans to small business owners.
It’s the very model of the Catch-22. We won’t give you a loan if you aren’t established and profitable. If that were the case, I wouldn’t need a loan.
Luckily, you can access financing other than personal credit cards and traditional bank loans. Asset-based loans (ABLs) provide you with an alternative source of financing.
What is an Asset-Based Loan?
You get an asset-based loan by putting up collateral owned by the business. In most cases, you offer up an asset that has high liquid potential. That means the lender can convert the collateral into cash quickly.
A few typical examples of assets put up for an ABL include:
- accounts receivable
Some lenders will also accept real estate, but there is a caveat. The more difficult something is to convert into cash, the less money the lender will provide.
For example, a lender might offer you up to 85% of the value of accounts receivable because it converts so easily. In contrast, equipment, inventory, and real estate might only get you a loan at 50% of their value. Turning that physical property into cash takes more time and effort if it becomes necessary.
You must own the property outright to use it for an ABL. If another creditor has a claim on that property, they can swoop in and claim it if you don’t pay them off.
Who Uses an Asset-Based Loan?
Manufacturers and service-based businesses can benefit from asset-based loans.
Let’s say you own a small factory that recently got a big order. You dumped a bunch of liquid capital into raw materials. Then you spent weeks making the products.
You ship them out and invoice the customer. Except, you happen to run on a net 30 or net 60 invoicing policy. After the shipment goes out, you might not see payment for two months, and you depleted your liquid cash.
Another big order comes in, but you lack the funds to order the raw materials. You can use that accounts receivable as collateral for a fast infusion of cash. You get the raw materials you need, and your business keeps on trucking.
How does this work for a service business? Let’s say that you run a floor cleaning business. Business picks up when fall and winter roll around because of the rain and snow.
People track in mud or slush, which means the floors need cleanings more often. You need more people to pick up the slack. As long as you invoice your customers in advance, you can use your accounts receivables the same way the factory owner does.
Benefits of an Asset-Based Loan
The most obvious benefit of these kinds of loans is that you get a cash infusion. The money lets you purchase materials, inventory, or hire additional employees when you need them.
You can secure asset-based loans much faster than a traditional loan as a general rule. Depending on the company, the turnaround time from applying to getting cash can prove as short as 48 hours.
It’s easier for you to secure this kind of credit than a regular business loan. Traditional loans hinge a vast cross-section of factors but mostly boil down to whether the bank believes you’ll pay them back.
Asset-based loans remove the issue of belief in you. The collateral is the guarantee of payment.
You also avoid putting up personal property, such as your home, to secure the loan. That helps ensure that your whole life won’t get destroyed if your business doesn’t thrive. This benefit proves especially crucial if you have a family.
Like any other line of credit, staying in compliance helps your credit score. That makes getting other forms of financing easier down the road.
That matters because your company is probably in a growth phase. Before too long, you’ll need those more traditional lines of credit to finance larger, more complex business deals.
Pitfalls of an Asset-Based Loan
The most significant risk you face with an Asset Based Loan is the loss of business assets if you don’t pay. Granted, this is a dramatic action that most lenders prefer to avoid because it costs them time and money. Still, they’ll do it if you don’t keep up on your payments.
That loss of assets reduces the value of your business. It also makes securing future financing that much more difficult, if not impossible for several years.
Asset-based loans can also prove more expensive over the long run. Before you ever apply, you must assess the value of your assets. This is time spent that could otherwise be spent working on your business generating new leads and increasing your revenue.
Lenders may add additional fees for asset-based lending, as well.
Many Asset Based Loans also remain at a static value. So, even if you put up collateral that grows in value, your loan remains the same. That means you face an even more profound loss if the lender seizes the asset.
Parting Thoughts on Asset-Based Loans
Asset-based loans provide business owners with another funding option during growth periods.
Unlike traditional loans, these loans don’t rely entirely on your personal assets and credit score. They depend on the assets your business owns, such as accounts receivable, equipment, or inventory.
You do face some downsides. You do run the risk of losing the asset if you don’t pay against the loan. Asset Based Loans can also prove more expensive.
On the upside, it can provide an influx of cash when you can’t find other sources of financing. It insulates your personal property if the lender takes the asset. Asset Based Loans also get approved faster.
Dealstruck specializes in business financing. For questions or more information about our financing options, contact Dealstruck today.