What is Asset-based lending?
Asset-based lending (ABL), is a type of loan that is secured by some form of collateral or assets owned by the borrower. ABL is usually meant for businesses and not individuals. Collateral can include inventory, accounts receivable (amounts that the company expects to be paid back by customers for goods and services provided; in short, money for sales done on credit), equipment, or real estate.
Having collateral reduces the risk for lenders. It is easier to qualify for a loan if you have collateral. But it is equally risky because if you fail to pay back the loan, your collateral asset(s) may be seized.
How does ABL work?
ABL lenders typically use a loan-to-value (LTV) ratio to determine the amount of funding that a borrower can receive. LTV ratio is the loan amount divided by the value of the asset being used as collateral. The more liquid (easier to convert to cash) your collateral, the higher your loan value is likely to be. If you put up your inventory as collateral, you might get a relatively lower amount approved as a loan compared to a certificate of deposit (CD) or securities. Property or real estate and other physical assets are more difficult to convert.
For example, if you are looking for a $150,000 loan to expand your business, and you use CDs, stocks, or bonds as collateral, the lender might approve 85% of the value of the asset. So if the asset is valued at $150,000, you might get a loan of $127,000.
On the other hand, if you have inventory valued at $150,000, you may only get 50% of the value approved at $75,000. Apart from this, you also need to factor in the interest rates that you have to pay which will depend on the credit history and cash flow of the business.
Things to consider before deciding if ABL is for you
Pros:
- It is easier to qualify for an asset-based loan because the risk is lower for the lender.
- Lower risk for the lender also means that the interest rates will be lower on the loan amount.
- You can use the funds received through ABL for various purposes since lenders don’t generally restrict the use of your funds.
Cons:
- What qualifies as collateral is decided by the lender.
- Even though the interest rates may be low, other charges such as evaluation and monitoring of the collateral, origination fees, etc., might cost you more.
- Your business assets may be claimed and sold by the lender to cover any losses if you fail to repay the debt.
