Definition and Example of Asset-Backed Lending
In asset-backed lending, a business pledges an asset or assets as collateral in exchange for a loan or line of credit. The loan may be secured by a variety of assets, such as accounts receivable, equipment, inventory, or commercial property.
Let’s say you run a manufacturing business. You need a loan to cover payroll expenses, but you don’t have a lot of cash on hand and find it challenging to get approved for traditional business loans.
After you do some research, you find a lender that offers asset-backed lending to similar businesses in your situation. You decide to move forward with this option and borrow money against your manufacturing equipment. By using your physical assets as collateral, you receive the funds you need.
- Alternate name: Asset-based lending, asset-based loans
- Acronym: ABL
How Asset-Backed Lending Works
Asset-based lending can be a loan or line of credit issued by a lender to a business. It can assist with working capital, debt refinancing, seasonal sales fluctuations, mergers, acquisitions, restructurings, and a variety of business needs.
While some lenders require one asset to secure a loan or line of credit, others may consider a combination of multiple assets. The value and quality of your inventory, equipment, or other collateral will determine the amount you’ll be able to borrow. Most lenders will allow you to borrow anywhere from 60% to 90% of your asset’s value.
If your business has difficulty qualifying for a loan because of bad credit or limited financial history, asset-backed lending can give you the chance to borrow money through your assets. While many types of businesses may be able to benefit from asset-backed lending, this form of financing is widely used by manufacturers, distributors, or wholesalers, and other businesses that are heavy in property, plant, and equipment (P&E), in inventory, and in accounts receivable (but thin in margins and/or over-leveraged),
Asset-based lending is a particularly good option for businesses that are seasonal, growing quickly, trying to meet a production budget, or in the ownership transition phase, and it offers far bigger financing amounts than small business credit cards.
Asset-Backed Lending vs. Factoring
Also known as “accounts receivable financing,” factoring is a cash advance on your business’s outstanding invoices. It’s essentially a type of asset-backed lending, because accounts receivable act as collateral and help secure funding from a lender. Unlike asset-backed lending, however, there are no monthly payments with factoring. The lender pays you your invoices in advance, usually subtracting a service fee. When your customers pay their invoice, the payment goes to the lender.
You’ll find that factoring companies usually only offer accounts receivable financing. Therefore, if you want to pledge an asset like equipment or inventory, they won’t be able to help you.