Businesses regularly need money. With asset-based lending, they can find money without touching their cash flow.
Small and growth-phase businesses often find themselves short of needed cash. They might foresee a payroll shortfall. They may need to prepare for seasonal business inventory. They may want to move into a new facility. Or, they may want to buy new equipment.
Fortunately, such businesses have borrowing options. But not all options are equal. Anyone we borrow from may have tax implications, even when it is from a family member or a close friend. Hence, it tends to become imperative to look at what borrowing money from parents tax implications entails before deciding to borrow. Sometimes, money comes with costs and risks that create more problems than they solve.
A money lender may opt to lend money on a business’s assets pledged as collateral. These lenders prefer assets with promising liquidity, and they will not lend capital equal to the assets’ value. With the assets used as collateral, the interest rates may or may not compete with other financing opportunities.
Asset-based borrowing is an easier way for some businesses to secure funds than seeking unsecured financing. Small and mid-sized businesses will apply for asset-based loans for various needs.
The Good about asset-based lending
Entrepreneur points out, “Asset-based loans can be a much-needed source of capital for companies that are rapidly growing, highly leveraged, in the midst of a turnaround or undercapitalized. Sometimes a company simply needs that infusion of cash to get over a financial hump or prevent growth from stalling out.”
Asset-based lending presents some advantages to the borrower:
- Asset-based lending is not based on your profile. It has less interest in your credit score or the business’s profit record. So, the loan goes through easier and faster than typical bank loans.
- If you acquire additional inventory, capital equipment, or assets, it can be added to the loan base which then can increase the loan.
- Asset-based lending can be appealing if the business is undercapitalized, on the verge of rapid growth, or needing cash to finance acquisitions for growth. In the construction industry, for example, you can learn how to leverage the value of your heavy equipment at https://equifyllc.com.
- Asset-based borrowing lets you build and improve your credit record with the lender. As your business grows, you will need that support and credit history.
The Bad about asset-based lending
Your loan default is not assumed, but it is always a risk when borrowing money.
Securing an asset-based loan depends on the lender’s perception of the assets’ value. They may want more financial data than you expect because they are effectively auditing the assets as potentially liquid. They may also audit the values periodically because any fluctuation in asset value impacts the collateral.
Lenders are likely to base their offer on a lower asset value than you expect. That means you receive less money than you may have calculated on, and you risk the loss of the asset at a lower price should you default.
If the asset appreciates, the lender will not increase the amount of the loan. That leaves you at a bigger loss if they lender sells the asset for profit to pay off your default.
You also risk over-mortgaging. You can wind up owing more on your loans than the assets are worth to you. For example, if you are borrowing against real estate as an asset, you may find yourself upside down when the real estate market drops.
The Ugly about asset-based lending
Entrepreneurs and startups may feel pressured to bail themselves out of cash problems with asset-based lending. But, it may not be their best option.
Perhaps, the worst thing about financing a business with asset-based loans is it fails to build credit. After all, the borrowing business is using its own assets as collateral, And, that makes your business appear financially unstable.
Some commercial lending banks charge audit fees and diligence fees in processing asset-based loans. For example, there may be costs related to frequent auditing requirements.
These fees and charges may increase the loan’s interest rate or final cost. Ironically, the attempt to solve financial problems could cost more.
If the lender finds asset-based lending time-intensive and cost-intensive, it will pass the costs along to the borrower. And, this only complicates worries about businesses with poor credit ratings who find asset-based loans their only option.
The business owner must also fear the loss of control. The asset-based lending agreement may authorize the lender to seize the collateral assets if the value of the borrowing base no longer supports the loan.
Asset-based lending
Huffington Post recommends, “Be sure to maintain close communication with potential lenders because when financial institutions are evaluating future prospects of a small business, it’s important that they understand not just the business model, the landscape, and the product, but also the team behind it.”
Businesses will borrow money from time to time. It often makes good sense and value to the business. But, if you keep the long-range, big picture in mind, you must consider how each move affects future plans. And, those plans should not include making lenders your major stakeholders.
There is no magic moment, no trigger for seeking an asset-based loan. You must understand how they work, what risks they entail, and what the impact will be on your bottom-line if you are unable to honor the deal.
What you need as an asset-based borrower
You need the business advisor who can create a financial plan that includes a total approach to your business financing. If it proves you have money hidden in your operating equipment, asset-based lending can help you use the cash you have already invested in the business as collateral for a new loan.
What you should do is look at how much money you need to accomplish your immediate goals. You must keep that plan narrow and clear because you don’t want to over-borrow. You may borrow more than you need, but you want to keep it within a budget for paying it down and off.
Then, you can locate the equity you have in real estate, vehicles, capital equipment, and other assets. You must understand the lender will likely discount the value you identify and, then, proceed with that assumption.
Beyond that, you want the lender willing to build relationships, knowledgeable about your business and its assets, and able to offer features like skip-payments.
Business is tough for owners. They often stretch to make things work and keep their heads above water. But, they also have opportunities to help things grow and expand. It’s tough to balance those needs, but with prudence and good financial advice, businesses as borrowers can make it work.
