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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 is brand new—or you’re growing, but not yet profitable? What if your balance sheet says you have plenty of assets, but your income statement tells a different story?
For businesses struggling to get business funding through traditional debt financing methods, there might be another way. It’s called asset-based lending, and it’s an option that focuses less on your business’s past, and more on your present and the future.
In basic terms, asset-based lending is when a borrower’s qualifications are determined based on fixed assets owned by the business. An asset-based loan or line of credit is secured by collateral—like your accounts receivables, equipment, or inventory.
In asset-based lending, that collateral you offer against your loan provides security that the lender will end up getting their money back in the end—even if things go south and you default on the loan. In this worst-case scenario, an asset-based lender can (usually—depending on your agreement) recoup their losses by seizing the collateral. In theory, the collateral you offer up against your loan is a valuable asset, and the lender isn’t too bad off liquidating that into cash if you can’t pay up.
While this may seem like a bad scenario for the borrower, asset-based loans pose a significant benefit: Because of the security provided by this balance-sheet collateral, asset-based lenders can often finance borrowers who might not be eligible for a more traditional business loan.
Most borrowers turn to asset-based lending because they’ve had bad luck with approval at 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—before you spend a chunk of time applying for a traditional loan.
Here are a few of the main reasons a business owner might pursue financing through an asset-based lender:
Compared with more traditional financing lenders, asset-based lenders are much less concerned with your business’s past cash flow, profitability, or even your personal and business credit scores. Again, it’s all about the security a valuable piece of collateral provides.
As a result, asset-based lending can be a great alternative for younger businesses who have yet to break even, as well as for entrepreneurs with poor credit.
Instead of digging into the past, as a traditional lender would, asset-based lenders focus more towards 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 and you’re good at convincing people it’s there.
Despite your credit rating, your revenue history, or your cash flow, you might have some assets lurking around on your balance sheet that the right lender could see as a major value. 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 use specific assets on your balance sheet as collateral, they’ll typically pose less of a personal risk.
As a business owner, you’ll always face some personal risk if your business can’t repay its debts. But in this case, that risk is mitigated at least to some degree by the value of the assets themselves.
If it’s physical or financially valuable, and if it can be easily liquidated into cash, then any asset can be considered for collateral with an asset-based lender.
A list of assets eligible for use as collateral in asset-based financing 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 who invoice 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 that asset-based loan your business qualifies for would be proportional to your receivables outstanding—so the more you’re invoicing, the more you’d be able to borrow.
It’s important to note that using accounts receivables as collateral for an asset-based loan is different from accounts receivable factoring, though. When working with a factoring company, the lender actually purchases your outstanding invoices outright in exchange for a flat sum, as well as for a percentage of payments received. Also, invoice factoring is typically used for 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 an asset-based lender.
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, as long as you make your payments on time, that inventory is yours to work with however you want. But if you failed to make payments or defaulted 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.
From manufacturing equipment to vehicles, or from commercial kitchen appliances to computer systems, almost any machinery or equipment owned by your business can be eligible collateral for an asset-based loan. If you can sell it for 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: all equipment needs to be owned outright in order to be eligible, and it needs to be owned by the business and not by you personally.
In certain cases, real estate held by a business—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 grab 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 it 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.
While we’ve covered the most common fixed assets used to secure asset-based loans, this isn’t an exhaustive list. Depending on your type of business, you might have other tangible assets you could use. Simply put—if you own it, and you can sell it, then ask your asset-based lender if it’s eligible as collateral.
Now that you know what asset-based lending is, why you might be interested, and what types of assets you could use as collateral for an asset-based loan, 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 is usually more lengthy and involved. Asset-based lenders tend to favor building long-term relationships with their borrowers—a process that requires extensive vetting, and a significant investment of time and resources from both sides.
Because of the time investment, asset-based lending probably isn’t a good fit if you need quick access to capital. The approval process can take months and would require extensive paperwork, interviews, and even an in-person audit of your company’s assets and financials.
But don’t let all that hard 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.
Before you begin working directly with an asset-based lender, you’ll want to get a firm grasp on your company’s financial standing. Yes, you’ll need to compile the usual suspects of financial documents—but you’ll also want to comb through their ins and outs to be sure you understand your assets, debts, profits and losses, and the future projections of your business’s growth. Doing so will give you a good sense of how asset-based lenders will approach working with your business in an asset-based lending situation. This is a great time to make an appointment with your accountant to go through your business’s “State of the Union.”
As a starting point, gather and review the following financial documents, as they’ll likely be requested by asset-based lenders as part of the application process.
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!
Since asset-based lenders care less about indicators of past success, like your personal credit score or revenue history, they put a higher premium on the value of assets owned by your business that they can use as collateral to secure a loan.
Of course, this means that, in order to secure an asset-based loan, your business needs to own assets of value that can act as collateral. Use these additional documents to determine (and prove) your goods, and their values, to your asset-based lenders:
Now that you’ve gathered this information about your assets, you’re ready to determine whether the assets on your balance sheet might be eligible for use as collateral to secure your loan.
After receiving your application, an asset-based lender will perform what’s called a UCC (short for Uniform Commercial Code-1) search on your company. This search will tell 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 against that property. In other words, the asset-based lender wants to be in 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 current 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. If you do have other 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.
While you don’t necessarily have to close out existing debt in order to obtain an asset-based loan, there’s a strong chance that doing so will make the application process easier.
If you’ve gathered all the right documents and checked up on your assets, the actual application process will be a lot simpler—though still more complicated than working with a traditional lender, most likely.
Complete your lender’s online application and submit the necessary paperwork electronically—or work with a third-party agency like Fundera to help you through the process. 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 month for the lender’s initial review. If the lender thinks you’re a strong candidate for an asset-based 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 their 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.
It’s important to take this as a preview of what the lender believes they’ll be able to offer rather than a final offer. It’s non-binding for both you and your asset-based lender, but it should still be a good sneak peek into what you might expect down the road. 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—you’re essentially committing to proceeding with the loan and the process of being approved for that loan.
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.
Again, more so than most traditional lenders, asset-based lenders put a particular emphasis on building long-term relationships with their borrowers. They’ll use this time to establish a rapport and evaluate whether they can foresee a positive relationship growing 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.
By the end of your audit meeting, you’ll likely have a strong 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. 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!
As with any major financial decision you’ll make as a business owner, the choice to pursue an asset-based loan for your business is one only you can make. But as you review the assets owned by your business, your credit history, and your past revenue, it’ll likely become clear whether asset-based or traditional lending will be the best avenue for your business.
When should you not consider working with an asset-based lender?
Well, again, it depends on your situation.
Generally, an asset-based loan comes with long terms and low interest rates—depending on the type of collateral you use to secure the loan and your agreement with the lender.
If you can stand to wait out the process, and don’t mind putting your valuable assets at risk (which is a big consideration you don’t want to take lightly), then an asset-based loan is worth it.
But on the other hand, business owners with solid personal and business credit scores, strong financials, and a few years of business under their belt might be better served working with traditional lenders that don’t necessarily require collateral.
Or, if you need a business loan quickly—and can’t stand to wait through the due diligence process of securing an asset-based loan—then a loan that funds over a faster period of time might work better. If this is the case, try a short-term loan or a shorter-term line of credit.
Otherwise, an asset-based loan is a great option for the right kind of business owner!