What is asset-based lending and how does it work?

Definition of asset-based lending

Asset-based lending - also known as asset-based finance - refers to an agreement under which a company borrows money against collateral. 

This collateral can include physical assets such as stock, equipment, machinery or property, or non-physical assets such as intellectual property or accounts receivable (unpaid invoices). 

What to consider with asset-based finance

Asset-based loans are often used to cover short-term expenses and fund growth within a company. Many SMEs have cash flow and liquidity problems and need working capital to cover business expenses.

Using assets as security to qualify for asset-based loans is an attractive option for many small- and medium-sized enterprises (SMEs) that might not have the credit history or facilities to secure a traditional bank loan. 

However, lenders will need to ensure that they are covered should the applicant default on payment. As a result, the lender may offer a loan amount that is lower than the value of the pledged assets so as to protect itself if the borrower does not pay back the loan.

How does an asset-based loan work?

Many SMEs fail to qualify for unsecured loans due to having a limited or poor credit history. If a company seeking a loan cannot present sufficient cash flow as evidence of its ability to repay it, the lender may prefer to approve the loan using company assets as collateral.

Asset-based loan amounts depend on the type and value of assets that are secured as collateral. Some lenders might prefer physical assets that can be easily converted into cash if the borrower defaults on payment. 

The lender will take ownership of the assets if the applicant does not pay.

A typical asset-based finance agreement works in the following way:

• An SME applies for an asset-based loan through a lender.
• Assets (such as equipment, machinery or accounts receivable) are used as collateral for the loan.
• The lender offers immediate access to capital with pre-agreed repayment terms.
• Either:

• The SME meets the repayment terms on time and the agreement ends with no long-term obligations.

• Or:

• The business defaults on the payments and the assets pledged in the agreement are taken by the lender.

Example of asset-based lending

ABC Supplier Ltd needs access to short-term funding of £10 000 (GBP) to pay its manufacturing costs, as it is currently offering invoice payment terms of up to 120 days to its overseas Buyers.

So, ABC Supplier Ltd applies for asset-based lending with a finance provider. The provider agrees to finance 90% of the desired amount - valued at £9 000 (GBP) - by securing the loan against ABC Supplier Ltd's assets. 

The loan is secured against ABC Supplier Ltd's equipment, worth £10 000 (GBP) - with the understanding that if it doesn't meet the repayment terms the lender will take ownership of that equipment.

ABC Supplier Ltd receives timely payment from its overseas customers and pays back the lender in full and on time. The loan agreement ends and there are no long-term obligations or repayment terms.

Benefits of asset-based finance

There are many benefits of asset-based lending, including the following:

• Firms get fast access to liquid capital to cover short-term business expenses.
• These loans are available to companies of any size, not just large corporations.
• Even if an SME has stretched its credit limit, it can still apply for asset-based finance.
• Companies can enjoy steady cash flow from the loan capital, providing opportunities for growth.
• Other forms of financing can still be used alongside asset-based loans.
• Asset-based loans are flexible because they can be taken as cash or as lines of credit.
• Companies are not obligated to disclose their intentions for asset-based finance.
• There are very few restrictions on what the capital can be used for.
• Lenders typically offer fixed and convenient repayment terms, meaning it can be easier for companies to plan and budget.
• Companies can provide liquid or physical assets as collateral for an asset-based loan.

Risks of asset-based lending

There are risks associated with asset-based finance. These include the following:

• If your company doesn't pay the money back, you could face charges and the lender may seize the assets you've put up as collateral.
• Your credit rating could be negatively affected if you do not make a repayment.
• If you default on payment and your assets are seized, it might be difficult to apply for finance again.

Therefore, it's crucial to consider all the pros and cons of taking out an asset-based loan.

Some asset-based lending agreements carry fewer risks than others. For example, borrowing against unpaid invoices - commonly known as invoice financing or invoice factoring - means that companies access finance only on funds already owed to them. For more information about how invoice finance works, refer to this guide. 

Am I eligible for asset-based lending?

A lender will look for the following information to determine whether a company is suitable for asset-based loans:

• Financial history - lenders might consider the company's financial history as part of their due diligence checks on the borrower.
• The amount of finance required - the value of the borrower's assets must cover the loan amount, plus extra to compensate the lender for turning assets back into liquid capital.
• The type of assets used as collateral - the lender will consider the value of the assets and determine how easily they can be turned into cash if needed. For example, many banks prefer liquid assets to physical assets because they are easier to turn into cash. 

If you are interested in learning more about the content listed above, Stenn has a dedicated FAQ section where you can find more information about our invoice financing services. We also provide videos which explain the company and the financing process in detail.

About the authors

This article is authored by the Stenn research team and is part of our educational series.

Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.

Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.

Check the financing limit available on your deal or go straight to Stenn's easy online application form.

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Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. It is for information only and doesn't constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.