Asset-based loans allow businesses to use assets such as receivables, inventories and equipment as collateral. Customer payments go directly to the bank to be applied to the loan, thereby minimizing idle cash and paying down high-cost debt. The company takes only what it requires to meet its cash needs for operating expenses, including payroll, supplies and overhead.
In 2003, there was $340 billion outstanding in asset-based loans in the United States, according to a survey by the New York-based Commercial Finance Association. That's up from $326 billion in 2002, and more than triple the $107 billion reported only 10 years earlier.
One reason for the surge is that asset-based loans are cheaper than many of the alternatives when companies need more capital than conventional bank loan underwriting standards will allow.
Businesses in transition due to growth, ownership change or restructuring may have financing needs that conventional lending won't meet. They may seek private equity funding or mezzanine financing (a hybrid of debt and equity funding), which most often come through venture capital or alternative lending firms that may be looking for returns of 20 percent and higher.
Although rates on asset-based loans tend to be higher than those for conventional bank lines of credit, they are usually significantly less than these other options. Keep in mind that using asset-based loans may only close part of the financing gap. Pricing for asset-based credit has decreased in recent years, as well, since the market has become more competitive.
One major difference between asset-based loans and their more conventional counterparts is the oversight lenders require. Asset-based lenders may be in almost daily contact with their clients to be sure they stay up-to-date on their collateral position, which can change daily.
That monitoring puts additional administrative burden on companies. However, the companies don't need to provide anything more than what they should already know just from being in business -- what was sold, what was collected, what was bought and what is owed to employees and suppliers.
Part of the oversight also includes periodic on-site field examinations of company books, with a focus on collateral value, and risk mitigation strategies such as customer verifications.
The more stringent monitoring is one reason lenders are willing to provide asset-based loans. Although from a lender's perspective, asset-based loans may appear to have more risk, losses are often lower than on conventional loans because asset-based lenders have more control and understanding of each borrower's collateral position.
More and more often, companies are using asset-based loans for even routine financial needs. Healthy companies that are contemplating an acquisition or product line expansion or that want to buy out an owner may find asset-based loans attractive. Asset-based loans revolve and they are self-liquidating, and they force companies to keep a very close watch on their finances.
The last attribute is one that some very successful companies greatly appreciate. One, for example, initially used asset-based lending during a transitional period, but continued with it because the owner found great benefit in the additional discipline it imposed on his managers. Asset-based loans minimized the company's debt usage (and therefore interest expense) and the owner knew every day what had been borrowed and what had been paid.
The stigma touching asset-based loans as recently as five or 10 years ago has disappeared, as companies recognize the value these instruments add not only during transition but also after stabilization. Asset-based loans may not be the best choice in every situation, but they give companies access to funds they would otherwise be unable to obtain, and make them pay closer attention to how they're using their money, as well.
TOM WATTS is senior vice president in the commercial banking department of MB Financial Bank. Reach him at (773) 328-7437 or www.mbfinancial.com.