Businesses that understand the unique advantages of asset-based loans (ABLs) gain a valuable addition to their financial toolkit. But those that use it without forethought can put themselves at considerable risk. 

Here is what every business owner needs to know about this unique way to unlock working capital.

Turning business assets into cash

ABLs let businesses borrow money against the value of their assets. These assets can be physical property, such as machinery, equipment, vehicles, or inventory, or they can be financial instruments, such as invoices, purchase orders, or contracts.

By borrowing against these types of assets, a business owner can unlock new sources of working capital, even if they don’t qualify for traditional loans. This can be a life-saver in cases where the business is experiencing a temporary downturn or needs to fund growth opportunities. And as you’ll discover in this article, not all ABLs deliver the same benefit to the business: some are considerably less risky and more flexible than others. 

The advantages of asset-based lending

ABLs offer a number of advantages over traditional loans and lines of credit. 

Accessible. First and foremost, this type of lending arrangement doesn’t factor in a business’s credit score or track record. Instead, it focuses on the value of the assets the business wishes to leverage, which means newer or more financially volatile businesses can qualify. 

Fast. ABLs can also be a quicker route to cash than other financing options. While traditional loan applications can take weeks or even months to process, an ABL application is a more straightforward process that can put cash in the business owner’s hands in as little as 48 hours. 

Flexible. ABLs generally have less restrictive covenants compared to traditional financing, which means the business has more freedom in terms of how to use the funds. Banks often impose strict requirements regarding debt ratios, profitability metrics, and operational decisions when they loan money to the business, while the main requirement for an ABL is that the business retain and maintain the assets being leveraged.  

Complementary. Traditional loans and ABL are not always an “either-or” proposition. Many business owners choose to maximize their access to working capital by topping up conventional loans with an ABL as needed. This approach gives them a higher borrowing capacity to help them reach their stretch goals or get through a temporary downturn.  

Understanding the risks and downsides 

ABLs can be a valuable financial tool for businesses of every size and type, but there are risks and downsides to consider. 

First, the less liquid the collateral is, the lower the loan amount is likely to be. For collateral such as equipment and vehicles, which depreciate consistently and take time and effort to sell, a business might receive a loan that represents only 60% of the asset’s actual value. However, for assets that represent more liquid value, such as purchase orders or invoices, upwards of 90% of the face value of the assets can often be realized.

The biggest risk associated with ABLs, however, is the risk of asset repossession, which could jeopardize the business’s ability to remain viable by delivering products and services to its customers. For example, if a transportation company secures loans against its fleet and is unable to meet its obligations as a borrower, the consequences could be catastrophic. However, not all ABLs carry this level of risk: options such as invoice factoring or purchase-order financing are less likely to disrupt business operations. 

Which businesses are a fit for asset-based lending? 

Whereas larger companies can draw needed capital from ready cash and traditional loan facilities, small and mid-sized businesses often lack these resources. ABLs are a good fit for these types of businesses when they have high-value equipment, machinery, vehicles, inventory, or outstanding invoices that can be converted into cash. ABLs can also help business owners avoid diluting ownership by raising cash through issuing shares in the company.

Invoice factoring: A low-risk, high-reward ABL 

One of the most enduringly popular forms of ABL is invoice factoring, because it offers the most advantageous ratio of risks to rewards. Invoice factoring allows a business to sell their invoices and receive the cash immediately, rather than having to wait 30 or more days for the funds to reach them. 

Unlike other types of ABL, factoring doesn’t put the business’s essential assets at risk of repossession, and it also offers the highest loan-to-value ratio of all ABL types. In other words, your business will see more than 90% of the face value of the invoice up front, while equipment and vehicle assets may yield as little as 60%.  

Invoice factoring also has no negative impact on your business’s credit score, so you can continue to improve your creditworthiness while you factor. If you work with a reputable factoring company, you can negotiate a flexible contract that gives you the cash you need immediately without locking you into a long-term commitment. 

Unlike other types of ABL, invoice factoring arrangements often include complementary value-added services, such as invoice management and collections support, which can reduce administrative strain and improve the consistency and predictability of your cash flow over the longer term. 

Learn more about turning invoices into cash

If you own a B2B business and would like to learn more about leveraging your invoices to free up working capital, talk to a factoring expert in your region.