A ledgered line of credit (LLOC) and an asset-based loan (ABL) can both provide flexible working capital. However, they work differently. This article explains the main differences between the two products so you can decide which option is better suited to your company. We cover the following:
- How do they work?
- Eligible assets
- Borrowing availability
- Accessing funds
- Costs and fees
- Line utilization
- Qualification criteria
- Reporting requirements
- Covenants and financial controls
- Minimum facility size
- Which option is right for your company?
1. How do they work?
Both a ledgered line of credit and an asset-based loan enable you to finance assets. The primary difference is how each facility is structured.
a. Ledgered line of credit
Ledgered lines of credit provide revolving financing secured by your company’s eligible accounts receivable. Your company’s availability increases as your company generates new invoices and falls as customers pay existing invoices.
Read “What is a ledgered line of credit? How does it work?” to learn more.
b. Asset-based loan
Asset-based loans combine revolving financing and term loans based on the collateral that secures the facility. Accounts receivable and inventory are financed using a revolving line. Other assets, such as machinery and equipment, are financed using a term loan.
Read “What is an asset-based loan? How does it work?” to learn more.
2. Eligible assets
LLOCs and ABLs are secured by business assets. The main difference is the type of collateral that primarily secures the line.
a. Ledgered line of credit
Ledgered lines of credit are primarily secured by your accounts receivable. Consequently, your accounts receivable must meet the finance company’s criteria for eligibility. These include invoice age, customer credit quality, and customer concentration.
b. Asset-based loan
Asset-based loans can be secured by a broader range of assets. The revolving component is secured by accounts receivable and inventory. The term loan component is secured by the fixed assets the company wants to finance.
3. Borrowing availability
Both facilities have a fixed credit limit and an advance rate, or margin rate. The credit limit sets the maximum amount you can borrow under the facility. The advance rate determines how much of the value of an eligible asset can be leveraged when you request funding, subject to the facility’s limits.
a. Ledgered line of credit
Finance companies determine the credit limit of a LLOC by taking into account the company’s financing needs, eligible A/R, and risk profile. The advance rate on A/R typically ranges from 85% to 90%. However, advance rates vary and can be higher or lower based on your company’s individual circumstances.
b. Asset-based loan
Determining the credit limit of an ABL depends on the assets being financed, your company’s needs, revenues, risk, collateral mix and quality, and market conditions. The ABL has an overall credit limit, and asset classes may have individual sublimits or caps. Each asset class also has its own advance rate used to determine the borrowing base.
| Asset | Advance % |
|---|---|
| Accounts Receivable | 80% – 90% |
| Inventory | 50% – 75% of NOLV (see note) |
| Machinery and Equipment | 50% – 70% appraised value |
| Corporate real estate | 65% – 75% appraised value |
Note: Many companies use the Net Orderly Liquidation Value (NOLV) of the inventory. However, some finance companies may use the Forced Liquidation Value (FLV) instead. This varies by lender and collateral quality.
4. Accessing Funds
The process of drawing funds from a ledgered line of credit is relatively simple. Accessing the funds through an ABL is generally more complex and depends on the type of asset securing the facility.
a. Ledgered line of credit
Drawing funds from a ledgered line of credit is relatively simple. Your company submits a list of invoices. Once approved, funds are deposited into your bank account. Note that some providers also request a copy of every invoice, though that varies.
b. Asset-based loan
Drawing funds from an asset-based loan depends on the type of asset securing the facility. Fixed assets, such as machinery, are funded through a term loan at closing. Current assets, such as accounts receivable and inventory, are funded through a borrowing base certificate.
This document is maintained by the client and tracks the value of accounts receivable and inventory. Funds are deposited into your company’s account once the borrowing base certificate is approved.
Read “How does a borrowing base certificate work?” to learn more.
5. Costs and fees
The cost of the facility is determined by its size, asset quality, and diversification. In general, asset-based loans are cheaper than a comparably sized ledgered line of credit.
a. Ledgered line of credit
LLOCs typically use the Prime rate as the reference rate. They are priced using a “Prime + X%” formula, where X% is the margin added to account for the line’s size and characteristics.
b. Asset-based loan
ABLs typically use the Secured Overnight Financing Rate (SOFR) as the reference rate. They are priced using a “SOFR + X%” formula, where X% is the margin added to account for the line’s size and characteristics.
6. Line utilization
Ledgered lines of credit and asset-based loans often have similar minimum utilization requirements. However, these requirements vary by provider and facility type.
a. Ledgered line of credit
Ledgered lines of credit usually require a minimum utilization of 40% of the credit limit. This means the company must keep at least that amount outstanding at any given time. Finance companies can adjust this requirement for companies that have highly seasonal revenues.
b. Asset-based loan
Asset-based loans typically require a minimum utilization of 40% to 50% of the accounts receivable portion of the borrowing base. However, the exact requirement varies by provider and facility structure.
7. Qualification criteria
There is some overlap in the qualification requirements for a ledgered line of credit and an asset-based loan. However, ledgered lines of credit have simpler requirements and less restrictive underwriting standards.
Asset-based loans, on the other hand, require a more comprehensive and expensive underwriting process.
a. Ledgered line of credit
Ledgered lines of credit have the following qualification requirements:
Read “Ledgered line of credit qualification requirements” to learn more.
b. Asset-based loan
Asset-based loans go through an extensive underwriting process before approval. This can include field examinations, collateral appraisals, and an exhaustive financial review.
ABLs have the following qualification requirements, although they vary depending on the assets being financed:
Read “Asset-based loan qualification requirements” to learn more.
8. Reporting Requirements
Ledgered lines of credit typically have simpler reporting requirements than those of an asset-based loan of comparable size. The reporting requirements for an LLOC typically focus on accounts receivable and the company’s financial health. Asset-based loans, on the other hand, require ongoing reporting for multiple asset classes, covenant compliance, and the company’s financial health.
a. Ledgered line of credit
The reporting requirements for a LLOC focus on the company’s A/R, its actual invoices, and the company’s financial condition. Finance companies typically ask for the following:
b. Asset based loan
The reporting requirements for an ABL focus on calculating the borrowing base, monitoring collateral, monitoring covenant compliance, and the company’s financial condition. Finance companies typically ask for the following:
9. Covenants and financial controls
Ledgered lines of credit and asset-based loans use covenants and controls to protect the finance company and its interest in the collateral. In general, LLOCs have fewer and simpler covenants and controls. Asset-based loans have more extensive controls, especially if the line includes multiple asset classes.
a. Ledgered line of credit
The covenants and controls of a ledgered line focus on the quality of the accounts receivable. Requirements vary by provider. However, finance companies typically require:
Some providers require additional covenants such as maintaining certain financial ratios at an acceptable level. However, these tend to be more flexible than those of an ABL.
b. Asset-based loan
Asset-based loans have more extensive collateral controls because the borrowing base often includes multiple asset classes. Financial controls and covenants vary by lender but usually include:
10. Minimum facility size
Minimum facility sizes typically vary by provider. Ledgered lines of credit are typically available to smaller companies than a full asset-based lending facility.
a. Ledgered line of credit
Ledgered lines of credit are typically available to companies that invoice a minimum of $1 million per month. The lines are also available to companies with seasonal revenues, provided annual revenue totals at least $12 million.
b. Asset-based loan
Asset-based loans are used by companies with larger financing requirements, especially if they have inventory, machinery, equipment, or corporate real estate. Lines are available to companies that invoice at least $2 million in A/R per month. Generally, ABLs are also available to companies with seasonal revenues provided annual revenue totals at least $24 million.
11. Which option is right for your company?
Companies that only need to finance their accounts receivable are typically better off using a ledgered line of credit than an asset-based loan. In our experience, clients find that the line’s simple operation and more flexible compliance requirements outweigh the slightly higher cost.
However, companies that have mixed collateral or are looking for the lowest possible cost should consider an asset-based loan. The extra reporting and controls may be worth it if your company needs lower costs or wants to borrow against more types of assets.
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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.