Asset-Based Lending - Explained
What is Asset-Based Lending?
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What is Asset-Based Lending?
Asset-based lending refers to an organizational borrowing backed up by a collateral security or asset. Asset-based loan is also known as line of credit that is backed by assets such as accounts receivable, inventory, equipment, or other assets that are a part of balance sheet. Asset-based lending is also called asset-based financing or commercial finance.
How Does Asset-Based Lending Work?
There are several reasons that influence organizations to take loans. It can be related to meeting their cash flow requirements, maintaining inventory, managing payroll, and a lot more. If a firm doesn't have enough funds to make payments for its loans, the lending party can issue loan on the basis of its assets. Such type of financing is referred to as asset-based lending. Asset-based lending takes place when a company gets loan on the basis of the worth of assets alone that are pledged as collateral security. Depending on the structure and worth of assets backed as security, the lender sets the rules and policies for asset-based lending. Usually, it is the preference of the lending party to consider assets that are very liquid in nature, meaning that they can be converted to cash as soon as the borrower fails to make payment. Hence, if the liquidity of asset is more, then the loan-to-value ratio will also be more. Also, a financial institution lending money to an organization will never lend money that is equal to the complete worth of assets pledged as collateral. For instance, a firm is planning to diversify its business, and hence, needs to borrow $200,000. For getting the loan, if the firm decides to place its marketable securities that are highly liquid in nature as collateral, it will be feasible for the bank or the lending party to issue a loan of 85% of the worth of assets. So, if the highly liquid assets of the firm are valued at $200,000, they can receive a loan of $170,000. In case, the firm lacks in highly liquid assets, and decides to pledge less liquid assets like real estate as security, then the bank may be able to give loan for half of the amount of the required amount. Asset-based loans have lesser rates of interests as compared to those of unsecured borrowings or line of credit. This is so because the lending party has the authority of acquiring assets, and further place them for sale for recovering the due amount of loan that the borrower fails to pay. The value of assets set as collateral by the debtor has a significant role to play in determining the amount of loan. An asset-based loans interest rate can vary anywhere from 7% to 17% depending on how big or small the loan is. This rate is represented in the form of annual percentage rate (APR). There can be several reasons that influence a company to use asset-based lending. Sometimes, it can be difficult for companies to issue securities including shares or bonds in the capital market owing to higher costs. Additionally, the firm can find it complicated to arrange quick funds for a project having a specific deadline, say a merger, acquisition, etc. When it is more of a challenge to arrange unsecured funds from the market, the company chooses asset-based lending. Usually, organizations experiencing steady growth and encountering cash flow related issues, select the option of asset-based loans. Small and medium-sized companies who are consistent, and have assets for collateral are usually asset-based debtors. Also, if a company pledges assets to one lender, it cannot use the same assets as collateral at the time of borrowing another loan. It can only pledge if the other lending party agrees to it.