What Is Asset-Based Lending and How Does It Work?

Last Updated September 18, 2024

Financing your business can be tricky. While there’s a wide breadth of lending options at your disposal, it can be intimidating to figure out how to sort through those options to determine which is best for your business. And for small businesses in particular, traditional options aren’t always attainable. For these business owners, asset-based lending can be a valuable solution.

But even if you think you have an understanding of asset-based loans, you might not know how it’s priced, what type of assets can be borrowed against, and what lending options are actually classified as asset-based lending.

With that being said, continue reading to gain a full understanding of asset-based lending to better prepare you for your funding journey.

What Is Asset-Based Lending?

Asset-based lending (ABL) is the process of borrowing money that is secured by an asset, or collateral. Asset-based loans or lines of credit can be borrowed against include:

• Equipment
• Property
• Inventory
• Accounts Receivables
• Marketable Securities

It is important to note that asset-based lending is a form of business financing, not consumer financing.

Why Businesses Utilize Asset-Based Lending

Businesses with larger transaction volumes and larger borrowing needs require custom solutions that meet those needs. Asset-based lending is a great option for businesses that have large assets that they can use to secure their financing needs.

For many businesses, traditional lines of credit may prove too restrictive while factoring and other alternative financing products may feel too cumbersome. Asset-based lines of credit are a useful tool for businesses that are interested in tapping into value locked in certain assets the business is carrying on its balance sheet.

Plus, qualifying for asset-based lending is pretty lenient compared to more traditional option. Even with a subpar business credit score, there’s a real chance you could qualify for an ABL solution.

Related: Can You Get a Small Business Loan With Bad Credit?

How Does Asset-Based Lending Work?

Lenders underwrite asset-based loans by advancing capital against near-term assets like accounts receivable, inventory, and equipment. This differs from traditional lines of credit that are either based on the cash flow of the business or secured by more illiquid assets like real estate. Given the liquid, ever-changing value of the assets securing the line, asset-based lending requires lenders to develop specialized capabilities in underwriting and monitoring these lines.

Related: What Is Working Capital Financing?

Fortunately for borrowers, many traditional banks have developed asset-based loan products that allow them to lend to qualifying customers more affordably and efficiently than ever, so think about contacting your current lender before seeking out alternatives.

Here’s an example:

A manufacturing business needs a $500,000 loan to expand into new locations. The business currently owns many of its own properties, along with other valuable assets including heavy equipment.

If the manufacturing business adds these highly liquid assets on its balance sheet, it can use them as collateral for an asset-based loan. The lender may loan 85% of the cumulative face value of the assets. If the business’ assets are valued at $1,000,000, the lender would be able to loan up to $850,000 – plenty to fund the $500,000 loan they were looking for.

The discount (or fee) represents the lender’s cost of converting the assets into cash in a potential loss.

Examples of Asset-Based Lending Options

Examples of asset-based lending for businesses include:

• Accounts Receivable Financing
• Equipment Financing
• Inventory Financing

Accounts receivable financing, equipment financing, and inventory financing are three of the most widely used forms of asset-based lending. They all work fairly similarly, as described in the above equipment financing example, with the obvious distinction of which asset is being financed.

How Is Asset-Based Lending Priced?

Asset-based lending is priced according to the lender’s expected return on investment. When a lender proposes any type of financing, they typically have an annual return that they’re looking to attain. When pricing an Asset-Based Line, lenders will often include additional fees along with interest to meet their targeted return.

The most common costs and associated with an Asset-Based Line include the following:

• Interest: Quoted as an annualized rate and applied to the borrowed funds outstanding. More often than not, the interest is quoted as a spread on Prime or LIBOR (e.g. Prime + 2.0%).
• Monitoring Fee: May also be referred to as a monthly service fee or lockbox fee. This fee can range from $500 per month to $10,000 per month depending on the size of the loan.
• Unused Line Fee: Typically charged each month to the average unused portion of the line. This percentage fee should be well below 1.0% and often falls between 0.10% and 0.35%. For example, if a business has a line of $2,000,000 and the average funds borrowed is $1,200,000 for a month, the lender may charge a fee of 0.20% against the average unused portion of $800,000, equating to $1,600.
• Commitment Fee: This is the fee to keep the Asset-Based Line open and available to the client. Most lenders charge between 0.25% and 1.0% annually.

How to Calculate the Commitment Fee

Commitment fees are charged annually on the undistributed portion of the line. Below is the formula:

Unused Credit x Commitment Fee Rate = Commitment Fee

Assuming your company has a $4,000,000 line and used $2,000,000 in the first year with a 0.10% commitment fee, here is how to calculate it:

$2,000,000 x 0.10% = $20,000

Commitment Fee vs Unused Fee

Commitment fees and unused fees sound similar because they are both charged on the unused portion of your asset-based line. However, there is a key difference between the 2 fees – unused line fees are charged monthly, while commitment fees are charged annually.

What If You Don‘t Quality for Your Bank’s Asset-Based Lending Program?

If you do not qualify for your bank’s asset-based lending program, you can turn to another bank, ABL-based solution, or alternative financing option that can help.

For example, you may not qualify for equipment financing, but that doesn’t necessarily mean you can’t qualify for invoice factoring, a popular alternative for business owners who may not have the collateral to qualify for something like equipment financing.

Factoring is very similar to accounts receivable financing, but it’s actually not considered an asset-based lending solution. This is because factoring isn’t considered a loan – there’s no borrowing involved. Instead, a provider will actually buy your unpaid invoices at a discounted rate. With AR financing, a bank’s customers will borrow against their invoices.

Factoring is especially useful in certain industries, such as the staffing and recruiting realm, where agencies don’t always have expensive physical assets that banks require to be used as collateral for equipment financing.

altLINE, an invoice factoring company, assists business owners improve their cash flow and working capital by purchasing their outstanding invoices. Many business owners choose to utilize factoring over asset-based lending because there’s no collateral involved (aside from the invoice itself) and they won’t have to file those invoices under their list of liabilities, since factoring is not a loan.

One of the biggest benefits of working with altLINE is that we complement and operate alongside a business’s current bank relationships. This prevents business owners from having to seek out an entirely new banking relationship or engage with an overly expensive independent financing company,

With a different risk appetite that focuses primarily on a business’s A/R and the business’s customers’ credit profiles, The Southern Bank’s altLINE program can assist when many traditional bank ABL programs may not. This willingness to say “yes” combined with a bank cost of funds makes altLINE the best call to make when a business’s primary lender is unable to move forward.

Case Study: Bank Refers Regional Distributer to altLINE

Businesses morph and grow and so should their financing strategies. Finding the right product at the right time can be difficult, but the payoffs can be enormous. This was the case for one midsized company looking to take advantage of market conditions and accelerate their growth through acquisition.

Company

Electrical Components Distributer in the Southeast

Background

A regional distributor of electrical components was in the midst of acquiring and rolling up smaller distributors in its current geographic footprint. Up until this point, the business had grown organically with the help of a line of credit provided by their traditional lender. Growth through acquisition had always been part of the plan, but the increased debt and resulting impact on near-term financial performance were causing the distributor to trigger multiple covenants in their current financing.

The bank valued and desired to maintain the real estate and depository relationships with the customer, but the distributor no longer met the criteria required for the existing line of credit. The discussions between bank and borrower became strained. The Relationship Manager realized the bank would either need to take on outsized risk or risk losing the banking relationship entirely. Rather than waiting for the inevitable, the Relationship Manager contacted The Southern Bank’s altLINE team to see how they could assist.

Outcome

With a warm intro and financials readily available, The Southern Bank presented a preliminary proposal for the borrower within the day. The altLINE team analyzed the customer list, the cash conversion cycle, and the typical transaction terms. The resulting proposal offered not only a soft landing for a business that no longer qualified for traditional financing, but the new line also increased the business’s overall borrowing capacity giving it a greater cushion as it pursued its rollup efforts.

The commercial banker and current lender maintain the primary banking relationship with the customer. As such, the bank is well-positioned to refinance the Asset-Based Line when the customer’s financials and business goals allow. In the meantime, the current lender is viewed as a problem solver by the customer and can sleep well at night knowing their customer’s needs are being met by a reputable lender.

Asset-Based Lending FAQs

Here are some common questions about asset-based lending answered.

Is an unused credit line a cash equivalent?

An unused credit line is not a cash equivalent because it becomes a liability once you draw money from it.

What is the accounting treatment for unused commitment fees?

The standard unused commitment fee accounting treatment is to offset them against the direct loan origination costs.

How do you calculate unused credit?

Here is how to calculate unused credit:

Total Asset-Based Line Size – Funds Borrowed = Unused Credit