Asset Based Lending: Its Advantages and Disadvantages

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If you’re looking for business financing to put toward renovations or expansion, to meet day-to-day expenses, or to take care of other business initiatives, asset based lending will help.

Businesses often face cash flow issues, and sometimes, finding a source of financing to give their cash flow a boost could be challenging. This is true now, especially now that banks don’t hand out loans to small businesses freely. Fortunately, a lot of alternative lenders stepped up to help.

If you’re looking for a way to get additional business financing to put towards renovations, expansion, meet day-to-day expenses, or other business initiatives, asset backed lending will help.

Here’s what you need to know about asset based lending, including its advantages and disadvantages.

What Is Asset Based Lending?

Simply put, asset based lending is a financing option based on a company’s assets. In this sense, the company’s physical and non-physical assets become the collateral for the loan. So if the company fails to make the required repayments, the lender can seize the assets and use them as payment for the loan.

The following assets are usually what small business owners use to secure such a loan:

Accounts receivable (A/R)
Real estate property
Equipment
Inventory
Purchase orders (PO)
Intellectual property

Since the lender ties the loan to the asset, the lending terms are usually more flexible with asset backed financing. For instance, the lending company could offer a low-interest loan with an extended repayment period. However, the borrowers must also ensure that the asset they’re pledging is more or less of the same value as the loan amount.

What Are the Advantages and Disadvantages of Asset Based Lending?

Now that you know the definition of asset based lending, let’s look at its advantages and disadvantages.

Advantages

Let’s look at the upside of asset based financing first:

Advantage #1. You Will Have Greater Spending Flexibility

Unlike other traditional and alternative loans wherein they’re granted for a specific business need, an asset based loan doesn’t have the same limitations. Once the lenders approve your loan and transfer the funds to your account, you can use it to pay for your day-to-day expenses, utilities, equipment, expansion, or renovations. Alternatively, you can use the funds to pursue time-sensitive business opportunities.

Advantage #2. You Can Enjoy an Instant Boost in Cash Flow

With asset based financing, you won’t have to worry about the lengthy approval processes, like those with traditional lending. As long as you can meet the qualifications that the lenders have imposed and pledge a valuable asset, you’ll have an immediate source of capital. As you acquire more assets for your company, you’ll also have better chances of higher loan amounts.

Advantage #3. Your Credit Portfolio Will Improve with Asset Based Lending

Asset based lending also gives you a chance to expand your credit portfolio. The more diverse your portfolio is, the better you’ll look in lenders’ eyes. Plus, if you make the required repayments on time, your credit score will increase. This will increase your chances of getting better loan terms in the future.

Disadvantages

Disadvantage #1. The Business Risks Losing a Valuable Asset

One of the biggest risks of asset based financing is losing an essential asset of the company. For instance, let’s say you own a construction company, and you put important machinery such as a crane up for collateral. However, if your company should fail to pay the loan, the lender can seize the asset. Then your company would lose that crane, causing a disruption to your operations.

Remember that in asset based lending, the asset is tied to the loan as collateral. If you default on the loan, you could lose one of your valuable assets.

Disadvantage #2. Lenders Generally Allow Only Low Valuations with Asset Based Lending

Lenders mostly base loan amounts on the asset you’re pledging. Chances are, you’ll probably get a low valuation for your asset. Even if your asset appreciates, the loan amount you’ll be eligible for won’t go up.

In other words, lenders will value your asset much less than what it would cost. In this case, the lender has the upper hand.

Disadvantage #3. You’ll Be at Risk of Over-Mortgaging

Over-mortgaging can result when the borrowers continually put their assets in line to get financing. As a result, they end up having more debt than equity. It’s worth noting that the value of your assets could go down. If this happens, you’ll end up owing more money to the lenders.

When you’re applying for asset based funding, be sure that you’re using your assets wisely. It’s easy to get carried away with lending, especially if you have big dreams for your business. But as much as possible, keep borrowing to a minimum and borrow only when you need it.

Final Thoughts on Asset Based Funding

Asset based financing is one of the most helpful resources for business owners who have a hard time qualifying for traditional loans. However, it is important to learn more. Understand how asset backed lending will help your business achieve its potential. Start by learning the advantages and disadvantages. In this way, you’ll know what you’ll be getting yourself into and avoid unexpected issues along the way.