Understanding Asset-Based Financing

Asset-based financing is a way for rapidly growing, cash-strapped companies to meet their short-term cash needs. In general, companies can tap their assets to generate cash flow through asset-based loans or through factoring.

The asset-based financial services industry has burgeoned in recent years, and small businesses have fueled much of its growth. Although a stigma is still associated with using your assets to get cash, this type of financing is becoming more popular.

Asset-Based Loans

When you apply for an asset-based loan, you pledge assets to secure a loan from a bank or a commercial finance company. You still own your assets, but if you don't make good on your payments, the lending institution can seize them.

Asset-based loans are typically for companies with less-than-perfect credit. Interest rates and fees on these types of loans have fallen in recent years due to intense competition, but generally they are higher than traditional bank loans. As with all commercial lending, rates are negotiable. Lenders will look at your credit record, how long you've been in business and whether your assets are liquid.

Accounts receivable and inventory are common collateral, but any asset might qualify. When you use accounts receivable to secure a loan, you can expect to get about 75 percent of the face value of your fresh invoices. The loan-to-value ratio drops rapidly for older accounts.

When you use inventory to secure loans, your lender will most likely use a bonded warehouse -- an approved warehouse used to store goods and monitor inventory -- and pass the cost on to you. Loan amounts vary widely from about 30 to 80 percent of the value of your inventory.

Factoring

For fast-growth companies with credit problems, factoring is a way to get needed cash in a hurry.

In contrast to accounts receivable financing, factoring means you actually sell your accounts receivable to a factoring company for cash. The factor assumes the credit risk for your outstanding invoices. You might get about 80 percent of your invoices' face value up front.

Once the factor collects, you'll get the remainder back minus fees and interest rates, which can be as high as 50 percent annually.

Advantages and Disadvantages

The main advantage of asset-based financing is that small companies can usually get more cash more quickly than they could from a traditional bank loan. Also, asset-based lenders and factors offer an array of services including accounts receivable processing, collections and invoicing.

The drawback of asset-based loans and factoring is the expense. Using your assets to generate cash flow increases your cost of funds and cuts into profits. You need to weigh your situation carefully and determine whether this type of financing is necessary to expand your company or keep it afloat.

If you're looking for this type of financing, consult your business peers and your bank for referrals. Or contact the Commercial Finance Association, a trade organization representing the asset-based financial services industry, for more information.