Asset-Based Lending: What, How, Why
By: Robyn Barrett
Businesses can experience cash flow shortages for a lot of different reasons, even when they’re generating significant revenue. Some common causes include:
- Misaligned Payment Terms: Customer payment terms don’t align with a company’s cash outflow requirements, including payroll and vendor invoices.
- High Growth: A company and its working capital needs are growing faster than the conversion of invoices to cash.
- Current lender issues: A company has an existing line of credit from a bank but is unable to increase availability due to customer concentrations, financial covenant defaults or negative financial performance.
Whatever the cause, cash flow shortages can quickly jeopardize a company’s ability to meet critical business needs and goals. To replenish working capital and get their companies back on track, business owners can turn to asset-based lenders for a beneficial liquidity boost. Unlike bank loans, asset-based lending can be a cost-effective way to access funds quickly by leveraging a company’s existing assets. In the following article, we’ll take a closer at what asset-based lending is, how it differs from traditional bank lending and why it makes good business sense for companies like yours.
What is asset-based lending?
Asset-based lending provides fast and flexible access to funds by leveraging a company’s existing accounts receivables and inventory. It can be used to finance current operations as well as future growth. With rapid processing times and competitive pricing and terms, asset-based loans can provide a welcome alternative to conventional financing options.
Since asset-based lending relies on a company’s asset quality versus the historical cash flow, this type of financing is especially beneficial for companies that are experiencing significant growth, seasonality or have other urgent cash needs.
How does it differ from traditional bank lending?
The primary difference between asset-based lending and traditional bank lending is what the lender looks at when underwriting a loan. A traditional lender looks first at the historical profitability and cash flow of a business, while an asset-based lender primarily looks to a company’s assets, which can include accounts receivable, inventory and, in some cases, equipment.
The asset-based loans are governed by a “borrowing base” of agreed-upon advance rates on the assets of the company and possibly financial covenants based upon the company’s projected financial expectations. Asset-based lenders rely on the creditworthiness of the borrower’s customers and their payment history to determine the borrower’s ability to borrow. By focusing more on the credit quality of the borrower’s customers, the asset-based lender oftentimes can provide higher advance rates (i.e., on the eligible accounts receivables and inventory) and availability than what may otherwise be available through traditional bank sources.
Why consider asset-based lending for your business?
Based on a company’s projected growth, asset-based loans can be far more favorable than other financing options on a number of fronts. Some of the key advantages and benefits to borrowers include:
- Speed: Asset-based loans can be approved faster and funded more quickly than traditional bank loans. This is due to asset-based lender’s higher reliance on the assets of the company versus historical cash flow.
- Flexibility: Asset-based loans typically do not require a fixed repayment schedule but are more flexible and based upon the company’s overall cash flow.
- Availability: Since an asset-based credit facility is based on the borrowing base of short-term assets, the credit availability can expand for growth situations, mergers or acquisitions. Asset-based lending is also a preferred solution for seasonal companies as the borrowing base can expand and contract with the borrower’s working capital needs.
- Competitive Terms: Asset-based loans typically offer more competitive interest rates and less stringent covenant restrictions than conventional financing. Bank owned asset-based lenders have an added advantage as they can utilize a bank’s lower cost of funds and its technology platforms to offer a competitively priced alternative to other sources of capital. As companies maintain deposits and use other bank products and services, the asset-based credit facilities may be priced at or near traditional bank rates.
- Flexible use: These loans are an appropriate fit for a variety of industries, including those which rely on set customer payment terms, such as staffing, professional services, manufacturers and distributors. They are also ideal for companies seeking to finance acquisitions or even partner or shareholder buyouts.
Choosing a lender
Many lenders offer asset-based lending, but it’s important to work with a lender that takes the time to understand your specific business, industry and cash flow needs. Key criteria for selecting a lender include a solid reputation and deep experience in the lending industry and with all aspects of loan structuring, including overall credit availability, terms and conditions, and interest rate. Even companies with existing bank or asset-based relationships should periodically explore the market for alternative options.
The bottom line is to choose a lender that offers solutions not obstacles.
Asset-based loans can offer a more flexible and competitively priced financing option for asset-rich and cash poor businesses. Oxford Commercial Finance, a subsidiary of Oxford Bank, is committed to the success of its clients in both good and challenging times. Our experienced team at Oxford Commercial Finance is dedicated to working with you to maximize your borrowing capacity, so you have the support and liquidity you need to grow your business today, tomorrow and beyond.
To learn more, contact our team today or visit www.oxfordcommercialfinance.com.