Asset-Based Lending: Guide for SMEs

Through asset-based lending, businesses can access credit against company assets. But as with all funding options, there are pros and cons to be considered.

The following essential guide looks at how asset-based lending works, from the different types of asset-based lending to the factors you should consider when looking at whether asset-based lending could work for your business.

 

What is asset-based lending?

 

Asset-based lending is a form of financing for a business that uses existing assets on its balance sheet as security against lending. In this way, a business can boost its current cashflow position or facilitate growth by leveraging the value of any untapped and unencumbered assets that it already owns. An unencumbered asset is one that is not being used as security for another finance facility, and is otherwise free of any liens or claims.

In theory, both physical and non-physical assets can be used as collateral for an asset-based loan.

When it comes to physical assets, these assets could include equipment, plant and machinery; freehold or leasehold property; inventory, such as raw materials, work-in-progress and finished goods; as well as debtors. In some cases, asset based lenders may also be prepared to lend money against the intellectual property owned by a business.

 

How does asset-based lending work?

 

Asset-based lending is a popular method used by businesses to borrow large sums of money by securing finance against a range of existing corporate assets. It also offers a relatively quick and convenient way to get working capital for your business without making a substantial upfront payment. This money can then be used for a variety of different reasons, including:

• to acquire new assets, such as machinery, equipment or vehicles
• to develop a new product or service
• to invest in materials, inventory or technology
• to help boost the cashflow of a business
• to fund expansion, for example, for new premises or to increase marketing spend
• to fund overseas expansion, for example, international exports
• to recruit new staff or train existing staff
• to refinance or restructure the business
• to buy out a founder or existing shareholder
• to acquire another company or business.

Asset-based lending can release working capital from the entire balance sheet of a business, including accounts receivable, inventory and property. As such, it enables businesses to generate the optimal level of working capital to drive scale and take their operations to the next level, where asset based lending is often used for strategic purposes, such as new acquisitions, management buyouts, or refinancing and restructuring.

Depending on the value of the assets being used as security, asset-based lenders can potentially provide loan facilities running into millions of pounds, subject to the business having enough collateral.

 

What are the different types of asset-based lending?

 

There are various different types of asset-based lending, depending on the assets used as security for a loan, such as accounts receivable. Accounts receivable refers to money owed to a business by its debtors, by way of outstanding invoices, where invoice finance represents one of the most popular forms of both asset-based and revolving lending. This is where a business borrows money on its invoices on an ongoing basis, as they are raised.

There are two main types of invoice finance: invoice factoring and invoice discounting. As accounts receivable finance, these two types of invoice financing allow a business to recoup early payment on some or all of its outstanding invoices in return for a pre-agreed fee.

In invoice factoring, the business effectively sells outstanding invoices to a third party finance provider at a discount. The business also relinquishes control of collecting and processing payments, which instead becomes the responsibility of the factor. In contrast, in invoice discounting, the finance provider loans the business money, and on which the business pays interest, where the unpaid invoices act as collateral for that loan. However, the business will retain control over its credit management process and debtor book.

Other types of asset based lending include equipment and property financing, where these can be used by a business to secure higher levels of funding than invoice finance alone.

 

Risks & benefits of asset-based lending

 

There are a number of benefits and risks relating to asset-based lending. On the plus side, this type of finance can be far easier to secure than a traditional style business loan, where asset based lenders will be far more focused on the nature and value of the assets being used as collateral, rather than the credit rating of your business. This type of finance is also relatively flexible, where there are few restrictions on how you can spend the loan facility.

Unlike equity finance, which requires you to sell a stake in your business, with asset-based lending your business can leverage its balance sheet without capitalising on any of its equity. This means that you may be able to borrow large sums of money, but still retain full ownership and control. Equally, funding can also grow as the value of any assets increase.

On the downside, even though you do not necessarily need a good credit history to secure asset based lending, a bad credit rating can still impact the interest rates charged by lenders. Interest rates can vary widely, and will also depend on other factors, including your cashflow and number of years trading, although the rates can often be high.

However, the greatest risk when it comes to asset-based lending is the potential to lose the assets against which the finance is secured. This is because if you default on your loan repayments, you will not only face financial penalties for late payment, any assets used as security for the loan can be seized and sold by the lender to discharge the debt owed.

 

Is your business eligible for asset-based lending?

 

To qualify for asset-based lending, you must be an established business with quantifiable, unencumbered assets. This means that you must have assets with untapped value. You must also have been trading for a minimum period of time, although the length of trading will depend on the lender’s criteria. However, without assets or any trading history, lenders will not be able to unlock the value of your assets by way of asset-based lending.

Additionally, when deciding whether to approve your application, asset-based lenders will not only consider the value and type of assets held, together with your trading history, but also the financial performance of your business. This is because they will need to be satisfied of your ability to repay the facility over the loan term agreed. The lender will usually look at your accounts and financial statements when assessing your eligibility. They are also likely to conduct due diligence. In some cases, the loan facility may be offered on a fixed term basis (such as for plant, machinery and property), while in others this may be on a revolving basis (such as for accounts receivable and inventory) but, in either case, you will need to be able to show the lender that you can easily meet the repayment terms.

As such, when looking to secure asset-based lending, you will first need to evaluate the balance sheet of your business to see if you have any assets of value. If you do, their total value could reflect, in broad terms, the amount of finance that you may be eligible for, where funding levels are directly linked to asset values. However, you will also need to ensure that you have detailed and accurate financial statements covering your trading history, where this information must clearly demonstrate your annual profit and turnover, with money regularly coming in to pay off your facility. The amount of revenue that you will need to show to be able to secure asset based lending will depend on the amount of lending sought, although most asset-based lenders will require a minimum turnover.

 

Things to consider about asset based lending

 

Before getting asset-based lending, in addition to establishing if your business is eligible for this type of finance and whether this lending is right for your business, you should consider exactly what you need by way of borrowing and the terms on which you are prepared to use your business assets as security. As such, you should always ask yourself the following key questions before proceeding with borrowing from an asset based lender:

• Does your business have assets of value on its balance sheet and do you know how much these assets are worth (where the value of these assets will have an impact on the size of the loan facility that you are offered)?
• Are you already using these assets as security for another form of finance (where an asset being used to secure an existing finance facility cannot be used as collateral)?
• Are you an established business (where asset based lenders will usually only offer loan facilities to businesses with a minimum trading history)?
• Are your finances in order and can you prove that you will be able to repay your loan (where your accounts and financial statements will need to reflect this)?
• Do you understand the asset based lending deal on offer (where you will need to know which assets are required for the security, as well as whether the terms and conditions, including the borrowing period, suit your business needs)?
• Do you know what the total cost of the loan will be to your business (where the overall cost will be based on the interest rate and loan term set by the lender)?
• Do you know if there are any charges for early repayment of the loan facility (where you must check the small print for any hidden charges)?
• Do you know how you will use the loan and how this will benefit your business (where you will need to forecast how the loan will positively impact your business)?

These questions can also be used as checklist to provide you with a clearer idea of what you need to do to prepare your business for asset based lending if you do decide to proceed.

 

How to apply for asset-based lending

 

There are various, specialist asset-based lenders across the UK, as well as mainstream lenders, including high street banks, who offer a number of different asset-based lending products. You can find these by searching online, where this type of lending is available in any region and for any industry sector, although you will often need a minimum turnover to apply. You must also be happy to use your debtor book and fixed assets as security.

Alternatively, if asset-based lending is not suitable for your business, either because the business is not eligible or you would like to explore alternative options, there are plenty of other types of funding available on the market that can be tailored to your needs. By seeking expert advice, you can explore these options with the help of a financial specialist.