Is Asset-Based Lending Right for Your Business? A Simple Guide

Learn how to evaluate whether asset-based lending could be the perfect financing solution for your business needs.

As a business owner, you’ve probably heard about asset-based lending (ABL) as a way to get funding for your company. But how do you know if it’s the right choice for your specific situation? In this guide, we’ll walk you through everything you need to consider to make an informed decision about whether asset-based lending could help your business grow and thrive.

Understanding Asset-Based Lending

Before we dive into whether ABL is right for you, let’s make sure we understand what it is. Asset-based lending is a type of business financing where you use your company’s assets – things like inventory, equipment, or accounts receivable (money customers owe you) – as collateral for a loan.

Think of it like using your house as collateral for a home equity loan, except you’re using business assets instead. The lender looks at the value of these assets and lends you money based on a percentage of that value. If you can’t repay the loan, the lender can take and sell your assets to recover their money.

When Asset-Based Lending Makes Perfect Sense

Asset-based lending is particularly well-suited for certain types of businesses and situations. If your business has substantial inventory that turns over regularly, ABL could be an excellent fit. For example, if you run a retail store, a wholesale distribution company, or a manufacturing business, you likely have significant inventory that can serve as collateral.

Companies with seasonal fluctuations often find ABL particularly helpful. Let’s say you sell winter sports equipment – your inventory builds up during the summer and fall, then gets sold during the winter months. Traditional banks might be nervous about these seasonal swings, but asset-based lenders understand this pattern and can provide credit lines that expand and contract with your inventory levels.

ABL also works well for growing businesses that need more working capital than traditional banks are willing to provide. If your business is expanding rapidly and you need cash to buy more inventory or hire more staff, but your profits haven’t caught up to your growth yet, asset-based lending can bridge that gap.

Finally, ABL can be a lifesaver for businesses going through temporary difficulties. If your company is fundamentally sound but facing short-term challenges – maybe you lost a major customer or had an unexpected expense – asset-based lending can provide the cash flow you need to get back on track.

When Asset-Based Lending Might Not Be the Best Choice

Asset-based lending isn’t right for every business. If your company is primarily service-based and doesn’t have much in the way of physical assets, ABL probably isn’t a good fit. For example, if you run a consulting firm, a marketing agency, or a software development company, you might not have enough qualifying assets to make ABL worthwhile.

Businesses with very concentrated customer bases should also be cautious about ABL. If most of your accounts receivable come from just one or two customers, lenders will view this as risky. They’ll worry that if you lose one of these major customers, you won’t be able to repay the loan.

Companies that already have strong cash flow and good relationships with traditional banks might not need the flexibility that ABL provides. If you can get the funding you need from a regular bank loan at a lower interest rate, and you don’t need the flexibility of a revolving credit line, traditional financing might be more cost-effective.

Evaluating Your Assets

To determine if ABL is right for your business, you need to take a hard look at your assets. Start with your accounts receivable – the money customers owe you. Lenders typically advance 70-90% of the value of good accounts receivable. “Good” means invoices from creditworthy customers that are less than 90 days old.

Next, consider your inventory. Not all inventory is created equal in the eyes of asset-based lenders. Finished goods that can be easily sold are more valuable than raw materials or work-in-progress. Inventory that’s current and in demand is better than outdated or specialized items that might be hard to sell.

Equipment can also serve as collateral, but lenders are usually more conservative with equipment valuations. They’ll consider the age, condition, and marketability of your equipment. A five-year-old delivery truck might be worth more as collateral than a specialized piece of manufacturing equipment that only works in your specific industry.

Understanding the Costs and Benefits

Asset-based lending typically costs more than traditional bank loans, but it offers benefits that can justify the higher cost. Interest rates are usually higher, and there are additional fees for things like monitoring your collateral and conducting periodic audits of your assets.

However, ABL offers several advantages that can make the extra cost worthwhile. You can typically borrow more money than with traditional financing because the loan is secured by your assets. The credit line is also flexible – as your assets grow, your available credit grows with them.

ABL lenders are also generally more willing to work with businesses that have credit challenges or are going through difficult times. They focus more on the value of your assets than on your credit score or financial statements.

The Application and Ongoing Process

If you decide to pursue asset-based lending, be prepared for a more involved process than a traditional bank loan. The lender will want detailed information about your assets, including aging reports for your accounts receivable and detailed inventory listings.

Once you have an ABL facility in place, you’ll need to provide regular reports to the lender about your assets. This might include monthly borrowing base certificates that detail your accounts receivable and inventory levels. Some lenders also conduct periodic field audits to verify your asset values.

While this might seem burdensome, many businesses find that the reporting requirements actually help them manage their business better. Having to track your assets closely can lead to better inventory management and more efficient collection of accounts receivable.

Making Your Decision

To decide if asset-based lending is right for your business, consider your specific needs and circumstances. If you need flexible financing that can grow with your business, have substantial assets to use as collateral, and are comfortable with the reporting requirements, ABL could be an excellent choice.

On the other hand, if you have access to cheaper traditional financing and don’t need the flexibility that ABL provides, you might be better off sticking with conventional loans. The key is to honestly assess your business’s needs and compare the costs and benefits of different financing options.