Many businesses today are looking for loans that can help their businesses advance in a market where credit standards are tighter than they have been in recent years.
During good or bad times, asset-based loans allow companies to leverage their assets to obtain the cash they may need, according to Robert Friend, a senior vice president with FirstMerit Bank. Asset-based loans are a working capital finance option available to business owners.
Smart Business spoke with Friend about the benefit of asset-based loans in today’s trying market and how business owners should prepare to apply for such loans.
How does an asset-based loan work versus a traditional loan?
An asset-based loan is structured using the value of the borrower’s collateral as opposed to financing that is primarily based on the borrower’s cash flow and overall balance sheet leverage. Because the conversion of collateral (accounts receivable and inventory) is the primary source of repayment, a major characteristic of an asset-based borrowing structured loan is the emphasis on monitoring the collateral.
Asset-based loans have the potential to provide a business with greater liquidity because the loan advances are based on the current level of the company’s working capital assets. These loans may be ideal for companies that are fast-growing or undercapitalized and need assistance to finance their working capital assets.
Have lending standards changed for asset-based loans?
In general, the lending and credit markets have changed dramatically this year with the failure of some major financial entities. This means that the scrutiny has increased for business loans. More and more banks are implementing some form of asset-based structure in the loans they are offering businesses.
On-site field exams are conducted by the bank to determine the advance rates on the collateral and other terms of the loan. Field examiners will review the accounting records, verify the account receivables and review the systems and procedures for recording and tracking inventory. This allows for a detailed and hands-on review of the company in addition to the traditional financial overview.
How can businesses prepare to apply for asset-based loans?
Accurate accounting records are critical in the bank’s ability to evaluate the quality of a company’s working capital assets. The accuracy and timely completion of financial records is essential to the bank obtaining a level of comfort with a company’s collateral and financial reporting. The borrower’s ability to provide financial data and collateral supporting schedules in an electronic format can greatly speed up the bank’s due diligence process. This leads to a quick response to the borrower and ultimately to better understanding of the borrower on an ongoing basis.
What types of business are best suited for asset-based loans?
Typical asset-based borrowers are heavily invested in working capital assets. These companies can be experiencing high growth or have seasonality in the business cycle.
Other candidates include turnaround situations, leverage buyouts and ownership transitions.
Are there any drawbacks to asset-based loans of which business owners should be aware?
Asset-based loans typically provide more borrowing capacity for a business. There are incremental costs for asset-based loans for field exams and monitoring fees. However, interest expense is minimized because the loan is repaid daily as accounts receivable are collected and borrowing only occurs when checks or other items are presented for payment.
ROBERT FRIEND is a senior vice president with FirstMerit Bank. Reach him at (614) 545-2763 or firstname.lastname@example.org.