Asset-Based Loans: A Comprehensive Guide for Businesses

Asset-based loans involve something physical (an asset) that is used as collateral for a loan. For most companies, it is inventory or accounts receivableAccounts ReceivableAccounts Receivable (AR) represents the credit sales of a business, which have not yet been collected from its customers. Companies allow that act as the collateral. However, any asset whose value can be accurately quantified may potentially be used as collateral.

Lenders who offer asset-based loans meet with the company, settle on the loan termsLoan CovenantA loan covenant is an agreement stipulating the terms and conditions of loan policies between a borrower and a lender. The agreement gives lenders leeway in providing loan repayments while still protecting their lending position. Similarly, due to the transparency of the regulations, borrowers get clear expectations of, and lend a percentage of the total value of the collateral that is being used. For receivables, the percentages are commonly somewhere around 80% of the value. With completed inventory, the percentage is typically about 50% of the inventory’s value. Whatever that percentage translates to in dollars is the amount that the borrower can receive as a loan.

Asset-based loans are an alternative way for a company or individual to obtain financing.

Summary

• Asset-based loans use physical assets (often inventory or receivables) to secure a loan that is a percentage of the assets’ value.
• Hard money loans are a type of asset-based loan.
• Asset-based loans are not risk-free for either lenders and borrowers. The lender must check the assets’ value carefully so as not to give a loan that can’t be recouped; the borrower may lose their collateral (assets) if they default or can’t repay the loan.

Security for Asset-Based Lenders

The assets used as collateralCollateralCollateral is an asset or property that an individual or entity offers to a lender as security for a loan. It is used as a way to obtain a loan, acting as a protection against potential loss for the lender should the borrower default in his payments. for an asset-based loan are – particularly for the lender – supposed to be valuable. This means that they are truly worth the market value that the lender uses to determine the percentage that is given as the loan. If the borrower subsequently defaults on the loan, the lender is secured with knowing it can seize the assets that serve as loan collateral.

Once seized, the lender can then liquidate the assets and recover the amount it paid out as the loan. This is why asset-based lenders look closely at the assets being offered as collateral; that is the lender’s primary focus. If the borrower is in any way unable to repay the loan, the assets can be used to secure a return of the loan amount to the lender.

Hard Money Loans vs. Asset-Based Loans

Hard money loans and asset-based loans are considered synonymous by many people, but can be distinguished from one another.

Hard money loans are an alternative to traditional loans and far easier to secure. They do, however, typically come with incredibly high interest rates and are an extremely risky way to get money. Real estate investors tend to prefer hard money loans because they use real estateReal EstateReal estate is real property that consists of land and improvements, which include buildings, fixtures, roads, structures, and utility systems. Property rights give a title of ownership to the land, improvements, and natural resources such as minerals, plants, animals, water, etc. as collateral for the loan.

Hard money loans are actually a form of asset-based lending because they use something physical as collateral. The primary difference is that hard money loans nearly always use real estate as collateral, while asset-based loans rarely use real estate as collateral, preferring to secure loans with other assets, such as inventory or receivables.

Related Readings

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