There’s an old – but not particularly good -joke about an amphibian seeking financing and a bank officer asking for collateral. The punch line goes, “It’s a knick-knack, Patty Whack, give the frog a loan.” (If you’re not familiar with the joke, contact Mike Anderson here at the office, and he’ll gladly tell it.) The joke illustrates a concept that even kids get: if you want to borrow money, you need to give something of value to the lender in return.
Business owners know loans don’t necessarily require giving an asset, knick-knacks or otherwise, to a lender. Lenders do, however, require some evidence they will at best receive repayment plus interest and at worst receive assets they can sell to recover payment. These are known as asset-light and asset based lending loans, respectively. Either can be appropriate for providing capital for your business, but each has its pros and cons. Here’s a quick primer on asset-based loans. We’ll discuss asset-light loans in a future post.
An asset-based lending loan requires collateral that, if you default on the loan, the lender can sell to recoup payment. Companies use this type of loan when the cost of issuing shares or bonds in the capital markets is too high; for relatively quick access to funds for time-sensitive needs like acquisitions; or when rapid growth has created cash flow problems.
A typical home mortgage is probably the best known example of an asset based lending loan. Collateral can be real estate, equipment, inventory or accounts receivable, although lenders typically offer a higher loan-to-value ratio for highly liquid collateral, such as securities.
Because they are secured by tangible assets, asset based lending loans are relatively easy and quick to get. You retain ownership and use of the equipment unless you default on the loan. These loans can be particularly useful for businesses with significant seasonal swings in cash flow, such as manufacturing, distribution or agriculture.
Annual percentage rate (APR) on an asset-based loan can range from 7 percent to 17 percent, typically lower than the interest on an unsecured or asset-light loan. That wide variance can make it difficult to estimate your cost of debt until you have an actual offer on the table. Be aware that the lender will not make a loan for the full value of the assets you pledge as collateral. A rule of thumb is 70 percent to 80 percent of eligible receivables and 50 percent of finished inventory.
In evaluating the risk of lending to your company, lenders will want to know your assets are in good standing, your customers pay their bills and you have significant accounts receivable. They will want verifiable information about the current value of the asset as well as its depreciation. The lender may also require a personal guarantee or that they receive payments directly from your customers.
Because of the cost to the lender of monitoring and auditing asset-based loans, smaller businesses may find it more difficult to locate a lender willing to handle a smaller amount. Good, professionally prepared financial statements and reporting systems that are detailed and accurate can make a lender more comfortable with a small company’s long-term viability.
Working with an investment banking firm like Bridgepoint Investment Banking can make lenders more comfortable with providing capital in the form of a loan to your company, regardless of its size.
We can help you navigate the various terms and requirements of lender offers to ensure you select the offer most beneficial to your company and your short-term capital needs.
Contact Bridgepoint Investment Banking for a confidential, no-obligation discussion to determine which kind of loan is right for you.