Asset-Based Financing 101

Once considered financing of last resort, asset-based lending and factoring have become popular choices for companies that do not have the credit rating or track record to qualify for more traditional types of financing.

In general terms, asset-based lending is any kind of borrowing secured by an asset of the company. For our discussion purposes today, we will consider asset-based lending to mean loans to businesses that are secured by trade accounts receivable or inventory.

 

Because asset-based lenders focus on collateral, rather than credit-worthiness, they do deals that more traditional lenders shy away from. Borrowers put up equipment, inventory, accounts-receivable and other liquid assets in exchange for the money. Asset-based lenders that are either nonbanks or separate subsidiaries of banks are not subject to such constraints. This gives asset-based lenders the freedom to finance thinly capitalized companies.

Your Guide to Asset-Based Lending Terms

• A revolver is a secured line of credit. The granting of the security interest to the lender creates a borrowing base for the loan. As receivables are collected, the money is used to pay down the loan balance.
• A “lockbox” or a “blocked account” is established by the lender for the receipt of collections of the accounts receivable. The company’s customers are instructed to pay their accounts to the lockbox, and the lender pays down the loan with these funds.
• Eligible inventory includes finished goods and marketable raw materials and excludes work-in-process and slow-moving goods. There could be additional limits on the advance rate for specially manufactured goods that can only be sold to a specific customer.
•  Purchase order financing can be used by companies that receive an unusually large order. The credit grantor accepts the purchase order from the company’s customer as collateral for the loan.
• Factoring is a financial transaction whereby a business sells its accounts receivable to a third party, the factor, at a discount to obtain cash. Factoring differs from a bank loan in three ways: (1) The emphasis is on the value of the receivables, not the borrower’s creditworthiness; (2) factoring is not a loan—it is the purchase of the receivable; and (3) a bank loan involves two parties whereas factoring involves three.