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If you’ve researched traditional small business loans, you’re probably aware that you need to have a profitable business, a strong revenue history, and a robust personal credit score to qualify for the best options. But what if that doesn’t describe your business just yet? What if your business’s revenue is impacted by seasonal cash flow dips—or you’re growing, but not yet profitable? In that case, asset-based lending can help you out.
To qualify for an asset-backed loan, your lender doesn’t focus as much on your business’s financial history and personal creditworthiness. Rather, lenders more heavily consider the value of your business’s assets, because the lenders use those assets as collateral in case you default on your loan.
Asset-based lending is a very specific type of financing product, though, so the loan application process is a little different from what you’d expect from a small business loan application. Read on for a comprehensive guide to asset-based lending, and how to ace the asset-based lending application process.
Basically, an asset-based loan is secured by tangible assets—or, whatever assets a business has on its balance sheets, and which can be quickly and easily liquidated. Assets like accounts receivable, equipment, and inventory are common types of collateral. Asset-backed loans are most often revolving lines of credit, but they can be structured as term loans as well.
Lenders base the amount of money you can borrow (aka the borrowing base) on the market value of your assets. Typically, businesses can borrow 75 to 85% of the value of their accounts receivables, and around 50% of the value of their inventory or equipment.
In asset-based lending, tangible collateral serves an important purpose beyond determining your borrowing base, too—it also provides security that the lender will end up getting their money back in the end, even if things go south and you default on your loan. In this worst-case scenario, an asset-based lender can recoup their losses by seizing that collateral.
In theory, the collateral you offer up against your loan is a valuable asset, and liquidating those assets into cash allows the lender to make up for most of their losses in case you default on your payments. For that reason, lenders consider the value of your assets heavily during the underwriting process.
Asset-based lending may seem like a bad scenario for the borrower—who wants to risk putting their business’s valuable assets on the line? However, asset-based loans pose a significant benefit: the security provided by this collateral mitigates the risk to the lender. As a result, you might have an easier time qualifying for an asset-based loan than an unsecured loan.
Note that we said easier, not easy. As with any small business loan you apply for, you’ll still have to meet the lender’s qualifications. Asset-based lenders also require potential borrowers to undergo a pretty involved due diligence process, too. (More on that later.)
Also keep in mind that most small business loans require some kind of collateral to secure, even if they’re called “unsecured.” The difference here, though, is that an asset-based loan requires a specific, balance-sheet collateral to secure the loan. Unsecured business loans, on the other hand, will usually require a business blanket lien to protect the lender’s interests, which gives lenders the right to any of the business’s assets. Or, those loan options might include a personal guarantee in its terms, which puts your personal assets on the line.
Most borrowers turn to asset-based lending because they’ve had bad luck getting approved by traditional lenders. But if you do your research, you might find that an asset-based loan is actually just the best choice for your business.
Here are five major reasons why you might pursue financing through an asset-based lender:
Compared with lenders offering unsecured loans, asset-based lenders are less concerned with your business’s past cash flow, profitability, or even your personal and business credit scores. Again, it’s mostly about the security a valuable piece of collateral provides.
As a result, asset-based lending can be a great alternative for younger businesses with valuable assets who have yet to break even, as well as for entrepreneurs with poor credit.
Young, quickly growing businesses often need working capital to keep up with increased demand. But it can be tough for new businesses to secure most types of small business loans, which often require a few years in business, and strong revenue across all those years, to be considered for loan eligibility.
Instead of digging into the past, as a traditional lender would, asset-based lenders focus more toward the future of your business. They’ll look at things like your sales and cash flow projections, and they’ll work to build a personal relationship with you to decide whether they think you’ll be a successful business owner or not. That’s good news if your business is in a high growth mode, or if your current revenue history doesn’t reflect your potential—but you know it’s there.
You might have some assets lurking around on your balance sheet that the right lender could consider valuable. Whether they’re machinery and equipment, inventory, outstanding invoices, or even real estate, those fixed assets can be leveraged as collateral to help you get the working capital you’re looking for.
Teaming up with an asset-based lender might let you fund your business’s next phase of growth—by using the investments you’ve already made. Easy peasy.
Many traditional lenders would require you to sign a personal guarantee or put up collateral, like a family home, to guarantee repayment in the event of a default. Because asset-based loans primarily use specific assets on your business’s balance sheet as collateral, they’ll typically pose less of a personal risk.
Asset-based lenders often don’t ask borrowers to sign a personal guarantee as additional collateral, but it’s always a good idea to check with your lender to make sure.
Asset-backed loans are often structured as lines of credit, which makes them a great financing solution for businesses with cash-flow issues. With a line of credit, you only take out the cash you need, when you need it, and you’ll only pay interest on the funds you draw. That’s opposed to a term loan, which you must repay in full, plus interest, whether you use those funds or not.
Plus, you can use those funds for a whole host of reasons. Here are just a few ways you can use your asset-backed loan:
You’ll probably need to indicate your intended use of funds on your loan application, and eligible loan uses are dependent upon the lender’s own guidelines. Generally speaking, though, asset-backed loans are much more flexible than other loans—especially bank loans, which are often more restricted in their allowed use of funds.
If it’s physical or financially valuable, and if it can be easily liquidated into cash, then any asset can be collateralized for an asset-backed loan. Clearly, a list of assets eligible for use as collateral in asset-based lending would be long—every unique business model has its own set of usable assets. However, there are some types of assets that asset-based lenders tend to favor over others.
Here are the five core asset types that lenders typically look for:
If you’re a service-based business that invoices customers, any receivables due within a 30- to 90-day window can be eligible as collateral for an asset-based loan. In this case, the size of the loan your business qualifies for is proportional to your receivables outstanding—the more you’re invoicing, and the greater the value of your invoices, the more you’d be able to borrow.
It’s important to note that an asset-based loan that uses invoices as collateral is different from invoice factoring. When working with a factoring company, the lender purchases your outstanding invoices outright in exchange for a flat sum, then collects your customers’ payments for you. Once they collect the full amount of your accounts receivables, they’ll pay you the difference but keep a percentage for their services.
So, where an asset-based loan using accounts receivables is a true loan, invoice factoring is actually a sale. Also, businesses typically use invoice factoring to free cash tied up in delinquent or past due invoices, while asset-based lenders will probably look at the sum total of your receivables.
If you operate a manufacturing, wholesale, or even retail business, chances are you’ve got a stockpile of product inventory on hand. That inventory could be saved for a rainy day, waiting to be sold or even transported. But for now, it counts as an asset on your balance sheet—and potentially valuable for asset-based lending.
Asset-based lenders can appraise that inventory to determine its resale value, and that value can be used as collateral to help you secure an asset-based loan.
If you take out an asset-based loan, that inventory is yours to work with however you want, as long as you make your loan payments on time. But if you fail to make payments or default on your loan, your asset-based lender would have the right to repossess that inventory (or other inventory of similar value) as repayment for your debt.
Manufacturing equipment, vehicles, commercial kitchen appliances, computer systems… almost any machinery or equipment that your business owns can be eligible collateral for an asset-based loan—like an equipment loan or business auto loan. As we mentioned earlier, if you can liquidate it into cash, you can likely put it up as collateral.
Generally speaking, the higher the value of your business’s owned fixtures, the more funds you’d be eligible to borrow. But remember: You need to own your equipment outright for it be eligible as collateral in an asset-backed loan. More specifically, your business needs to own that equipment, not you personally.
In certain cases, any real estate that a business holds—like owned retail or manufacturing space, land owned by a development company, or other real estate property—can be considered as a fixed asset eligible for asset-based lending. Usually, though, these situations are tricky, and need to be evaluated on a case-by-case basis.
If you’re interested in using real estate holdings to secure an asset-based loan, you’ll first need to get an independent appraisal to determine the property’s market value and any appreciations.
Keep in mind that if you’re paying a mortgage on the property, you’ll need to have paid off a significant portion in order to use that property as collateral for your loan. Asset-based lenders can only consider the real equity component of your real estate holdings—that is, those portions that you’ve paid off and own outright. The mortgaged value of your property can’t be used as collateral, since your mortgage provider already has first rights to that property value in the event of a business failure or default.
We’ve covered the most common types of collateral used to secure asset-backed loans, but this is by no means an exhaustive list. Depending on your type of business, you might have other monetizable assets on your balance sheet that you can leverage to secure an asset-backed loan—the Italian bank Credito Italiano, for example, even takes cheese as collateral for its small business loans!
We can’t guarantee that your lender will accept wheels of Parmigiano-Reggiano in return for cash. But if you own it, and you can sell it, then it’s worth asking your asset-based lender whether it’s eligible as collateral.
Now that you know what asset-based lending is, let’s take a deeper look into the process of applying for financing through an asset-based lender.
Compared with more traditional lending options, the application process for an asset-based loan may take more time and involvement on both sides—the approval process can require extensive paperwork, interviews, and even an in-person audit of your company’s assets to ensure its liquidity. Because of the time investment, certain types of asset-based lending may not be a good fit if you need quick access to capital.
But don’t let all that work scare you off—an asset-based loan could be well worth the effort. If you’re willing to be patient, and you believe that an asset-based loan is the best way to finance your business, here are the steps you’ll want to follow to set your business up for success with your asset-based lender.
Even before you apply for asset-based lending, you’ll want to get a firm grasp on your company’s financial standing. Yes, asset-based lenders are primarily concerned with the value of your business’s assets—but that doesn’t mean they don’t care about your business’s financial standing.
Your asset-based lender may or may not request to see all of the following financial documents, but you should comb through each to understand your assets, debts, profits and losses, and the future projections of your business’s growth. Doing so will give you a sense of how asset-based lenders approach working with your business. This is a great time to make an appointment with your accountant to help you out.
In the world of asset-based lending, your balance sheet is the single most important indicator of your business’s financial standing, as well as your eligibility for funding—after all, your balance sheets offer a direct look into your assets.
Most commercial loan brokers recommend having accurate balance sheets on hand both for your business’s year-to-date operations and for the two prior fiscal years. If you use business accounting software like Quickbooks, you should be able to pull your balance sheets easily.
This shows your company’s revenue and expenses. While this document is far less important than the balance sheet for asset-based loans, it’s helpful to include a year-to-date profit and loss statement (updated within the last 60 days) as well as total P&L statements for the last two years.
Asset-based lenders tend to focus on the future success of your business, rather than its history. So, if you have a well-researched sales forecast that tracks a strong growth trajectory, that may help to tip the scales in your favor.
If you’ve been in business for a while, have your last 2 to 3 years’ worth of business tax returns on hand. Also provide at least four months’ worth of banking statements, six if you have them, and 12 if your business is seasonal. For each month, remember to include all pages of the bank statements, not just the first.
Having reviewed your general financials, you’re ready to zero in on what’s most significant to your asset-based lending application… you guessed it—your assets!
As you now know, asset-based lenders put a high premium on the value of your business’s assets, which they can use as collateral to secure a loan. Use these additional documents to determine (and prove) your goods, and their values, to your asset-based lenders.
If you operate a service-based business in which you invoice clients, compile an accounts receivables aging statement that shows which invoices are outstanding, along with due dates and any past due invoices. Most basic accounting software will let you easily generate an AR aging statement, or you can create your own manually using a simple spreadsheet.
Assemble a list of the inventory you have, where it’s stored, and its approximate resale value. Note that if your inventory were to be liquidated in the event of a default, your lender would probably have to sell it at a lower price than your customers would ordinarily pay—so the resale value will be less than the product’s retail value.
Make a list of each and every piece of equipment or machinery your business owns, including vehicles, manufacturing equipment, kitchen appliances, fixtures in your retail store—even cash registers or computer equipment.
Detail each item’s purchase price, whether it was purchased new or used, its age, where it’s stored (i.e. warehouse location), and its condition. Research average depreciation for the equipment to estimate its current value, or work with an appraiser to get an independent valuation. Record all values in a spreadsheet to give your lender along with the rest of your application.
Once you’ve gathered this information about the assets on your balance sheet, you can determine whether they’re eligible for use as collateral for an asset-backed loan.
After receiving your application, an asset-based lender will perform a UCC (Uniform Commercial Code-1) search on your company. This search tells the lender whether any other creditor has a legal interest—known as a general asset lien—against your personal or business property.
Asset-based lenders look for borrowing relationships where the borrower’s assets are “free and clear,” meaning no other debtors have rights to that property. In other words, the asset-based lender wants to be in the first position to repossess those assets in the event of a default. If you’ve got other outstanding debt, or you’ve signed a collateral agreement on an existing loan, it’s possible that first rights to your assets are tied up with another lender—and the asset-based lender in question will have to get in line before they can recoup their losses.
If you’re not sure whether there may be a general lien outstanding against your property, it might be worthwhile to perform your own UCC search to determine your status. You can search online for the state in which your business is registered, and see if they have their own UCC filing search database.
If you do have outstanding debt, talk to your current lenders and make sure you understand the status of that debt, and how those debt claims impact your business’s fixed assets. You don’t necessarily have to close out existing debt to obtain an asset-based loan, but there’s a good chance that doing so will make the application process easier.
The next step is to complete your lender’s application and submit the necessary paperwork. Alternatively, you could work with a loan specialist to help you through the process.
Be aware that some lenders might require that you have your financials audited by a third-party agency before your application can be processed, so check directly with your lender to clarify first.
Once you’ve officially submitted your application, you might need to wait for up to a few weeks for the lender’s initial review. If the lender thinks you’re a strong candidate for an asset-backed loan, they’ll contact you to begin the due diligence period of your application.
Lenders have to put in a lot of work to complete due diligence for asset-based loans—so they might ask you for a preliminary commitment. Otherwise, they run the risk of putting in all that time and effort for a borrower who doesn’t follow through.
Their request for this due diligence commitment will likely come after they finish an initial review of your application and financials. At that point, if the lender is interested in working with you, they’ll present a preliminary offer detailing the loan amount, interest rate, and terms they might be able to provide.
Remember that this a non-binding preview of what the lender believes they’ll be able to offer, not a final offer.
If you’re interested in the lender’s preliminary offer, they’ll ask you to sign a term sheet and pay a due diligence fee for their work. At that point, you’re essentially committing to proceeding with the loan approval process.
As part of the due diligence process, your lender will conduct a field audit of your business. During the audit, a representative will meet with you in person to gauge whether there’s a good fit between you and the lender. They’ll visit your office space, audit your accounts receivable documents and other financial paperwork, and examine any physical assets—like inventory or equipment—that will serve as collateral for the loan.
Asset-based lenders put a particular emphasis on building long-term relationships with their borrowers, even more so than most traditional lenders. They’ll use this time to establish a rapport with you, and to evaluate whether they can foresee a positive relationship in the future. Don’t be intimidated by the nuts and bolts of the auditing process—instead, see it as an opportunity to build a friendly and professional long-term relationship with your lender.
Note that if you are approved for an asset-backed loan, your lender will continue to perform periodic audits of your collateral to check up on its value.
By the end of your audit meeting, you’ll probably have a good sense of your relationship with your lender—and whether they’re likely to approve you for funding. At that point, all you can do is wait.
After you’re approved for your asset-backed loan (congratulations!), there will likely be some paperwork to sign. But once all the documentation is executed, you should have cash in hand within just a few days after closing.
As with any major financial decision you’ll make as a business owner, the choice to pursue an asset-backed loan for your business is one only you can make. But as you review the assets your business owns, your financial history and projected financial growth, and why you need your loan, it’ll likely become clear whether asset-based lending or traditional lending is the best avenue for your business.
When should you not consider working with an asset-based lender? Well, again, it depends on your situation.
Business owners with solid personal and business credit scores, strong financials, and a few years of business under their belts might be better served by a traditional loan, which isn’t contingent upon the value of the business’s assets.
But if you’re a quickly growing business with easily liquidated assets on your balance sheets, asset-based lending could provide you with the cash you need to keep up with your growth—especially if you’re having a hard time getting approved for a traditional loan option.