Asset-based loans (ABLs) enable companies to get financing by leveraging their accounts receivable, inventory, and other assets. These loans are a popular option for companies due to their flexibility, simpler qualification requirements, and easier compliance.
This guide helps business owners understand how ABLs work, which assets can be financed, what lenders look for, and how much an ABL costs. It helps you determine if asset-based loans are right for your company. The guide covers the following subjects:
- What is an asset-based loan?
- What assets can it finance?
- Types of asset-based loans
- Can they help your company?
- How do they work?
- How much do asset-based loans cost?
- Due diligence process
- Small business alternatives
1. What is an asset-based loan?
Asset-based loans are a specialized type of financing that provides funding based on the value and quality of your assets. This funding differs from conventional bank loans, which emphasize cash flows.
Financing lines can be structured as revolving lines, term loans, or as a combination. The asset-based loan’s structure depends on the underlying assets pledged as collateral.
These loans have simpler qualification requirements and are easier to manage than comparably sized conventional loans. They are attractive to small and middle-market companies that need financing but can’t obtain conventional bank financing.
2. Assets that can be financed
Asset-based loans typically finance high-quality assets that have an existing market. These assets include accounts receivable, inventory, equipment, and machinery. Some lenders can also finance corporate real estate. Loan structure varies according to the assets securing the loan. The table below shows the typical structure for each asset type.
| Asset | Structure |
|---|---|
| Accounts Receivable | Revolving Line |
| Inventory | Revolving Line |
| Equipment | Term Loan |
| Corporate Real Estate | Term Loan |
Note: Click here for an image of the table.
a) Accounts receivable
Accounts receivable (A/R) are the most common asset that companies finance because doing so improves cash flow. These lines cover invoices from high-grade payers that are payable in less than 90 days (some exceptions apply).
The A/R component of an ABL is typically structured as a revolving line. These lines are often the backbone of most ABLs for small and middle-market transactions.
b) Inventory
Inventory lines allow companies to leverage their existing pre-paid inventory. To qualify, the inventory must be high quality, marketable, and in good condition.
These lines are used as an add-on to an existing A/R line and are also structured as revolving facilities. Transactions are settled once the item is sold, and the transaction becomes an account receivable.
c) Equipment and machinery
Equipment and machinery lines enable companies to leverage these assets for additional funding. The assets must be in good condition and owned by the company. These components are typically financed using a term loan structure.
d) Corporate real estate
Some asset-based lenders finance the company’s real estate, while others only do so as an accommodation for select clients. The facility is set up as a term loan based on the building’s appraisal, available equity, etc.
3. Types of asset-based loans
Several products could be referred to as “asset-based financing.” However, the term “asset based loan” typically refers to the following solutions.
a) Ledgered lines of credit
Sales ledger financing, commonly referred to as a ledgered line of credit, works like an ABL that finances accounts receivable only. It provides revolving financing secured by your A/R.
Ledgered lines have grown in popularity due to their simpler compliance and qualification requirements. Furthermore, they cater to smaller firms, which is not the case with conventional ABLs.
Read “What is a Ledgered Line of Credit? How Does it Work?” to learn more.
b) Asset-based loans (conventional)
Conventional asset-based loans finance multiple asset types and can combine different structures. Lines can be structured as term loans, revolving lines, or as a combination based on the assets securing the transaction. Asset-based loans have fewer covenants and simpler compliance than conventional bank loans.
4. Can an ABL help your small business?
Asset-based loans are not for every business. However, they should be able to help your company if it meets the following criteria.
a) Does your company qualify?
Asset-based loans are available to larger small businesses and to middle-market companies. Most lenders require the company to have minimum annual revenues of $10,000,000 (ten million dollars). Additionally, your company must have:
- Reliable financial reporting
- Financial controls
- Organized tax records
- Eligible assets
Read “Asset-Based Loan Qualification Requirements” to learn more.
b) Qualifying assets
Your company must have quality assets that can be leveraged. These assets include:
- Accounts receivable
- Inventory
- Machinery
- Equipment
- Real estate
Additionally, most asset-based lenders require that the accounts receivable line be the backbone of the facility.
c) Business need
Asset-based loans can serve several purposes. These purposes include:
- Improving cash flow
- Financing growth opportunities
- Replacing an existing lender
- Handling a “special assets” referral
- Turning around a distressed company
5. How does an ABL work?
The operation of the line varies based on assets pledged as collateral, which determine the facility’s structure. Accordingly, an ABL facility can contain revolving lines, term loans, or both. These components typically work independently, except for lines that use inventory.
Read “What is an ABL? How Does it Work?” to learn more.
a) Accounts receivable
The component of the line that is secured by accounts receivable is typically structured as a revolving facility. The line allows your company to draw funds as needed, up to the credit limit. The line is typically settled when invoices are paid.
Most lines allow your company to leverage 80% to 92% of your A/R. Your industry, dilution, invoice quality, and other criteria determine the exact percentage.
b) Inventory
Inventory lines are typically offered as an add-on to an accounts receivable line. They are also structured as a revolving facility. Note that inventory financing can be offered only to companies with a perpetual inventory management system.
Lenders typically advance 50% to 75% of the inventory’s appraised value. Some lenders appraise inventory using the Net Orderly Liquidation Value (NOLV), while others use the Forced Liquidation Value (FLV). It depends on their risk tolerance and lending practices.
Financed inventory is tracked through its life cycle until it is sold. At that point, it becomes an invoice and is handled through the A/R line.
c) Equipment and machinery
Equipment and machinery are typically financed using a term loan. Lenders appraise the assets and then lend 50% to 70% of the appraised value. The loans are paid in regular installments over 36 months with a balloon payment at the end.
d) Corporate real estate
Some asset-based lenders also lend against corporate-owned real estate, such as manufacturing plants, warehouses, management offices, etc.
The real estate must be inspected and appraised just as it would be in conventional real estate transactions. If approved, the lender can lend 65% to 75% of the appraised value. Financing is structured as a term loan that is available in regular installments over 180 months with a balloon payment at the end.
e) Line operation
Lines use a borrowing base certificate to determine the amount you can draw from the line. It is updated regularly with information about new and paid invoices, advance percentages, and ineligible invoices. The certificate relies heavily on your company’s financial reports.
Resource: Borrowing base calculator.
6. Cost
Most asset-based loans are priced using the Federal Reserve’s Secured Overnight Financing Rate (SOFR) with an incremental “uplift.” The “SOFR + X%” pricing model is applied to all components of the ABL. However, each component has a specific incremental “uplift”(e.g., X%) based on asset quality and size.
Note that all figures and calculations are for illustration purposes only. Read “Asset-Based Loan Costs Explained” to learn more.
a) A/R and inventory lines
Revolving lines secured by accounts receivable and inventory typically have fixed maintenance and utilization costs. These costs are charged monthly.
For example, a small line may have a SOFR + 9% utilization cost. Assuming a SOFR of 4.5%, the yearly utilization cost would be 13.5%. A larger line may have a SOFR + 4.5% utilization cost. Using the same SOFR assumption, the yearly utilization cost would be 9%.
b) Equipment and machinery
These loans typically have a 36-month term with a balloon payment at the end. The company must make a payment every month. Rates for these loans are typically about 2% higher than the cost to finance A/R and inventory.
c) Corporate real estate
These loans usually have a 180-month term with a balloon payment at the end. The company must make a payment every month. Rates for these loans are typically about 1% higher than the cost to finance A/R and inventory.
7. Due diligence process
All transactions undergo a comprehensive due diligence examination. This process varies by lender, transaction size, and complexity.
Companies typically charge for due diligence. This charge is used to cover examination expenses, legal documentation, third-party providers, etc. Due diligence typically covers three areas.
a) Financial review
Lenders typically review a few years of past financial reports and tax returns. The actual list varies by lender and transaction but typically includes the following:
- Profit & Loss
- Balance Sheet
- A/R Aging
- Payables Aging
- Debt schedules
- Tax returns
- Asset list
- Liabilities list
Some lenders hire an external firm to review and examine your financial records to ensure accuracy. Often, they will travel to your corporate site.
b) Asset appraisals
Lenders typically use external appraisers to examine the company’s assets, which serve as collateral for financing. This activity may include an appraisal of all equipment, machinery, and inventory. The field examiners need to visit every company location that houses these assets to perform their exam.
c) Company assessment
Lenders may also review all company details that are relevant to the transaction. This activity has no set process since every company and transaction is unique. However, this assessment typically includes:
- Company organization agreements
- Client contracts
- Current loan documents
- Forbearance agreements (if applicable)
8. Small business alternatives
Companies that are unable to get an asset-based loan have other alternatives. These options include the following.
a) Invoice factoring
Companies that have accounts receivable but cannot qualify for an ABL should consider invoice factoring. Factoring lines offer similar benefits but have simple qualification requirements and compliance. Read “How Does Factoring Work?” to learn more.
b) Small Business Administration (SBA)
The SBA offers several financing options to small business owners. They are competitively priced and have simpler qualification and compliance requirements than comparable products.
Note that the loans are not provided directly by the SBA. Rather, the SBA provides certain guarantees to lenders who work with small businesses.
Need asset-based financing?
Commercial Capital LLC is a leading provider of asset-based financing. For more information, get an instant quote or call us toll-free at (877) 300 3258.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.