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Asset-based lending (ABL) is a type of business financing that takes a company’s assets into account when determining whether a borrower may be granted a loan or line of credit, rather than just its financial performance or credit history.

Businesses may turn to ABL if they need funds quickly or have many assets and minimal cash flow.

How Does Asset-Based Lending Work?

Asset-based lending is a type of financing that requires companies to use their assets as collateral — similar to how people use a home as collateral for a mortgage.

Business owners can pledge various types of assets as collateral so long as a lender will accept them. They may also be able to combine assets to increase their borrowing power. Eligible assets could include:

• Inventory
• Equipment
• Real estate
• Accounts receivable
• Cash and securities
• Intellectual property

With an asset-based loan or line of credit, lenders could choose to focus on the value of the company’s assets more than their cash flow when determining financing amounts and terms.

Asset-based financing: An example

Consider a toy manufacturer that’s gearing up for a busy holiday season. As summer gives way to fall, it needs to buy supplies and hire temporary staff to fulfill incoming orders. But it doesn’t have much cash and won’t collect payments for the orders until the end of the year.

The manufacturer could consider using its accounts receivable or facilities as collateral for ABL and open a line of credit. If approved, it can take a loan – also referred to as a draw — from their line of credit that can help cover immediate expenses.

Why Choose Asset-Based Lending?

Traditional banks and non-bank commercial lenders may offer ABL. There can be downsides to this source of business funding, including the cost of financing and the risk of losing the assets. However, ABL may be a good fit for certain types of businesses.

Pros and Cons of Asset-Based Lending

Even within a single category, such as ABL, the specifics vary from one lender to the next. But here are some general pros and cons to consider.

Pros of asset-based lending

Some of the advantages of ABL include:

• Funds when you need them: ABL may offer a relatively quick and easy application and funding process. Companies may also be able to use the funds for almost any business purpose.
• Approval is often based on the assets themselves: Because ABL largely depends on the asset’s value and quality, companies with low margins or a short credit history may have an easier time getting approved for ABL than other types of financing.
• More flexibility: ABL may offer more flexibility than some other types of financing because the credit limit may be linked to the current value of the assets.

Cons of asset-based lending

Here are some potential downsides of ABL to weigh:

• Not all assets will be accepted as collateral: Lenders might not accept certain types of assets as collateral, including past-due receivables, branded inventory, specialized equipment, or real In short, the lender is likely looking for assets that they could sell quickly so they can receive the amount they are owed.
• Assets may be undervalued: Lenders typically only extend a portion of the asset’s value depending on the type of asset, how easy it is to liquidate, and an inspection or appraisal of the asset. For instance, a company might be able to borrow up to 85% of the value of its accounts receivable, but only 60% of its inventory’s value.
• Chance of losing assets: Because the assets are collateral, they are at risk if the borrower defaults on the loan.

Asset-Based Lending Could be an Option for Your Business

Asset-based lending could be a good fit for companies that have valuable assets and need cash quickly – and many small business owners may find this financing option could be the solution they need to address potential gaps in their cash flow or struggles to expand. Other factors to consider with ABL include how the costs and terms compare with other types of financing.

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