What are Asset Based Loans and Why Should You Consider One?
Since the economic crash of 2008, business loans have become more and more difficult to get for many small-business owners. And although it appears that there is a slight increase in lending from the big banks, lenders have a long way to go to ensure that small-business owners get the capital they need to grow and maintain their companies. In fact, the most recent (2013) Small Business Lending Index shows a 63 percent business loan approval rate from alternative lenders, compared to around 17 percent from small banks. Bigger banks did better, at a little over 40 percent. The results were based on companies that had been in business for longer than two years and had an average credit score of more than 680. One form of alternative lending that small business owners are turning to is asset based loans. Here’s a rundown on what they are, how they work, and some of the reasons why you might consider one.
What Is an Asset Based Loan?
This type of loan is ideal for a business that has a lot of inventory, accounts receivable, or equipment, but needs the funds to grow the business or get through a cash flow crisis. In the past, business owners would typically turn to their banks for a line of credit, but these days banking requirements make that impossible for those without pristine credit and a solid business history. The solution for many is an asset based loan, which is essentially an immediate cash infusion based on tomorrow’s sales.
How Do Asset Based Loans Work?
The loan, or in some instances line of credit, is secured by accounts receivable, finished inventory, raw materials, equipment, machinery, real property, or other assets owned by the business. These loans are different from say, factoring, because you don’t sell the assets, but rather only borrow against them. And since the assets are used as collateral, if you don’t make the payments, the lender can take them. Some loans are based on only one asset, while others are based on a combination of them.
The lender will advance a percentage of the total value of the assets. For example, typical advances for accounts receivable are 70-80 percent, while inventory generally nets less. It’s important to shop around for the best deal because the terms can vary wildly. The interest rates are higher than traditional loans, but lower than unsecured loans such as merchant cash advances. In addition, depending on the lender, there will likely be accounting fees attached to the loan because the lender will conduct audits in order to monitor the business. Some lenders don’t charge these fees, but make up for it with higher interest rates. Be sure to take the interest rate, the advance amount offered, and all fees into account when comparison shopping for your loan.
Who Benefits From Asset Based Loans?
Any business owner who needs cash, but is unable to secure it with a traditional lender might benefit from an asset based loan. Yes, you’ll pay higher fees than you would on a traditional loan, so you’ll need to seriously weigh the pros and cons, but if you need cash to keep your business going, it just might be the solution you’re looking for. Here are some of the reasons to consider this type of loan.
- You’ve been turned down by a bank or other traditional lender because your credit isn’t pristine.
- You need to hire more employees, but don’t have the cash flow to make additional payroll.
- You’re short on cash to pay your suppliers and you don’t want your credit rating or business relationships to suffer.
- The market is ripe for expansion, but you lack the funds to do so.
- You need to purchase more materials to fill the orders you have.
- You need cash immediately and don’t have time to wait for the traditional loan approval and funding process.
Do Asset Based Lenders Work with Small Business Owners?
Asset based lenders are known for working with large manufacturing businesses and those in the high dollar business-to-business industries. But if you log onto the Commercial Finance Association’s “Find a Lender” page, you’ll find a long list of asset based lenders that deal with loans of $250,000 and less for all types of businesses.
One of the traits that defines entrepreneurs is that they never give up, even in the face of adversity. If you’ve been unable to qualify for a traditional loan and it’s hurting your business or keeping you from expanding, talk to some asset based lenders to find the deal that best suits you.
Suzanne has been a full-time freelance writer for 20 years. She’s written for numerous business and financial publications such as Entrepreneur, Reason Magazine, Home Business Magazine, and Money Crashers.