Why Asset-Based Lending is Ideal for Small Businesses
You might think that small businesses don’t have much access to financing. After all, it seems that every other business on the Internet has an article about how they can’t get a loan or can’t find investors to fund their startup. But the truth is that there are plenty of lenders who want to help small businesses. In fact, there are many different kinds of financing that smaller businesses can take advantage of.
You just need to know where to look and what type of financing will work best for your specific business needs. If you have been exploring financing options for your small business, you probably know about Small Business Administration (SBA) loans, angel investors, venture capitalists, and maybe even friends and family who will be willing backers if things go south. But you may not have heard about asset-based lending as an option for funding your small business.
What Is Asset-Based Lending?
Asset-based lending is a type of financing that uses your business assets as collateral. In other words, the lender gives you money based on the value of your equipment and real estate. Asset-based loans are common with smaller loans, such as those under $250,000 and often shorter in length than traditional bank loans.
Asset-based lending can be offered by banks and private investors who specialize in providing funding against assets such as equipment, real estate, and accounts receivable. If you need a larger amount, you can also find asset-based loans from hedge funds and private equity firms.
Why Is Asset-Based Lending Such a Good Option for Small Businesses?
First of all, asset-based lenders are willing to lend to businesses that might not qualify for a loan from a traditional bank. Smaller businesses, startups, and even self-employed individuals who may have a less-than-ideal credit profile can still get funding from an asset-based lender. Another reason that asset-based lending is such a good option for small businesses is that the process is often quicker than traditional bank loans.
Asset lenders can make decisions very quickly because they don’t have to do thorough due diligence on each borrower or go through a lengthy approval process. In fact, you could have funding in your bank account in as little as a week after applying for an asset-based loan.
How Does Asset-Based Lending Work?
An asset-based lender will review the value of your equipment, real estate, and other company assets to determine how much they are worth. Once they come up with a number, they’ll decide how much they want to lend you based on that amount. If you need $250,000 to fund your business, but your equipment is valued at $300,000, the lender will lend you the $250,000 you need plus $50,000 in profit. With traditional bank loans, you’re usually assessed based on your credit score and other financial indicators such as the amount you make and your debt-to-income ratio.
Important Things to Know Before You Sign on the Dotted Line
It is important to remember that when you take out an asset-based loan, you’ll lose ownership of the assets that you use as collateral. If you default on the loan, the lender will take the assets and sell them off, regardless of their value at the time. If you default on an asset-based loan, the lender has the right to take your equipment and sell it off, regardless of its value at the time.
A lender may require you to put up your company’s real estate as collateral for an asset-based loan. If you do this, make sure your lender has a recourse loan, which means they have the right to take your property in the event of default.
Benefits of Asset Based Lending for Small Businesses
– Access to more funding: Because asset-based lenders only care about the value of your assets, they can lend you much more than banks and traditional lenders. You can often get funding for $1 million or more through asset-based lending.
– Quicker funding: Asset-based lenders have a very quick turnaround time. Whereas banks and traditional lenders can take months to approve applications and get money flowing to borrowers, asset lenders can close on funding in as little as a couple weeks.
– Funding for high-risk businesses: Because asset-based lending is based on the value of your assets, you can take out funds even if you have a low credit score or a poor financial history. – No collateral required: Unlike traditional lenders, some asset-based lenders don’t require you to put up collateral such as real estate or stocks and bonds. – No equity required: And while traditional lenders want you to put up equity in your business, sometimes asset-based lenders don’t even want that.
Drawbacks of Asset Based Lending for Small Businesses
– No government guarantees: While some traditional banks are backed by the federal government, asset-based lenders have no such guarantees. If something goes wrong with your business or you default on a loan, the lender has full authority to take back their money, even if it’s from your equipment or real estate.
– High interest rates: Because asset-based lenders take on more risk than traditional banks, they charge high interest rates. You can expect to pay anywhere from 12% to 30% or more on an asset-based loan. – More expensive than traditional loans: Unlike banks and other traditional lenders, asset-based lenders don’t give you a $100,000 loan and expect you to repay $100,000.
Instead, they charge you a percentage of how much they loan you. So if they loan you $100,000 and lend you the money at a rate of 15%, you’ll repay $115,000. – Riskier than traditional loans: Asset-based lending is riskier than taking out a traditional loan. If you default on an asset-based loan, the lender can take your equipment and sell it off to recoup as much money as possible.
Things to Consider Before Committing to an AB Loan
– What happens if your business goes bankrupt? If you default on your loan, your business could go bankrupt, and the lender could take your equipment anyway. This is why it’s so important to only borrow what you can reasonably repay. You don’t want to take out a loan that will put your business in jeopardy if you can’t pay it back. – What happens if you sell your business or retire?
You’ll have to find a new owner for your company to take over your loan. If you sell your business, you’ll have to make sure the new owner is willing to take on the loan as well. – What happens if you want to buy more equipment? If you want to buy more equipment or need more funds to expand your business, you may need to repay your current loan before you can get a new one.
The Catch: You’ll Lose Your Company’s Assets
One thing to keep in mind while taking out an asset-based loan is that if you default on the loan and the lender repossesses your equipment, it will likely be worth significantly less than what you originally agreed upon. For instance, let’s say you take out an asset-based loan to purchase new equipment for your business.
The lender agrees to loan you $250,000 based on the value of the equipment. But then the economy takes a nosedive, and your equipment becomes obsolete. The equipment is now only worth $25,000, but you still owe the lender the $250,000. This is the catch with asset-based loans. If your equipment and other assets take a nosedive in value, the lender can repossess the equipment and sell it off to get their money back. In the process, they might sell it for much less than it was worth when you took out the loan.
If you’re a small business owner, you’ve likely explored all types of financing options. You’ve likely considered SBA loans, angel investors, venture capitalists, and even friends and family members who might be willing to put up money. And now you’re learning about asset-based lending as another financing option.
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