Growing a business can require taking financial risks, but without the necessary capital, those ventures — and their potential benefits — can remain unexplored. Asset-based lending (ABL) enables companies to leverage their assets to their advantage by collateralizing their intrinsic value without having to relinquish ownership. Explore asset-based lending below to determine its viability for your business and discover how your company’s assets can become its greatest investment in future growth.

What is asset-based lending (ABL)?

Asset-based lending describes a type of lending agreement between a middle market company or corporation and a lender, rather than a lender and a consumer. Within the lending agreement, the borrower pledges collateral — i.e., its assets — to secure a loan or line of credit. Most middle market companies leverage primary assets like accounts receivable (AR) and inventory, with typical advance rates between 80% to 85% for AR and 50% for inventory. They may also utilize additional assets like machinery, equipment, real estate, or other assets with liquid value.

Within an asset-based lending agreement, the lender typically oversees the asset’s valuation. Most lenders prefer liquid collateral, as it minimizes risk. In addition, lenders tend to assign interest rates based on traditional creditworthiness factors, like credit history and cash flow.

Although ABL was once primarily an alternative for businesses that couldn’t access traditional sources of capital, it’s now become more mainstream. Thriving businesses and those struggling to scale have come to rely upon asset-based lending as a viable source of growth capital. Asset-based lending can also be particularly beneficial for companies that have liquid assets they can draw upon to secure a loan, including manufacturers, retailers, distributors, and wholesalers.

What business needs does ABL fulfill?

Asset-based lending is an ideal middle market banking solution for working capital, M&A financing, recapitalization, refinancing/restructuring existing debt, turnaround financing, and new capital expenditures. Businesses that leverage ABL can better manage cash flow, cover short-term expenses, and maximize borrowing capacity to promote success. However, some assets are not ideal for ABL, including specialized assets and perishable goods that are challenging for the lender to offload should the borrowing company default.

Main components of asset-based lending.

Before lenders draw up an asset-based loan agreement, they must first verify or assess the value of the collateralized asset to determine the exact loan amount available to the borrowing company. Fluctuations in an asset’s value can potentially influence available credit, within the lender’s discretion. The percentage of the asset’s value that’s available to the company is known as the “borrowing base.”

When the borrower pledges a particular asset, it must also enter into a covenant agreement that states it won’t leverage the asset elsewhere, as this could negate the lender’s right to seize and liquidate the asset if the company defaults. Lenders typically monitor a borrowing company’s finances regularly to mitigate the risk of defaulting on the loan. In addition, the borrower must maintain a working relationship with the lender to ensure the availability of future funds.

What are the benefits and challenges of ABL?

It’s important for middle market companies to recognize what’s at stake with asset-based lending, as it directly affects business longevity. By exploring the bigger picture and key details about ABL, companies can better determine if this type of lending aligns with their long-term financial strategy. The chart below summarizes the benefits and risks companies take on when they tap into asset-based lending:

ABL advantages

• Asset valuation can potentially offset newer/lower business credit history and increase the company’s chances of loan approval 
• Access to competitive interest rates
• Flexible financing allows the company to apply funds as it deems appropriate 
• A company can quickly access capital to flourish and scale 
• Lower interest rates than unsecured loans
• Leverage existing assets instead of selling off company equity 
• Requires less of a company in the way of income forecasting and consistent cash flow 

ABL disadvantages

• Some assets may not qualify in the eyes of the lender 
• The borrowing company is subject to monitoring and reporting requirements as part of the covenant and loan terms
• Lending fees (origination fees, audit fees, due diligence fees, etc.)
• Lender seizes assets if the company defaults on the loan, potentially crippling the business (depending on the collateral) 
• Interest rates can be higher than traditional loans due to the risk involved 
• The application process can be slightly more complex, depending on the lender, the asset valuation protocol, and the asset(s)
• Fluctuating loan ceiling, as loan amounts typically can’t exceed the asset’s value

Specific advantages and disadvantages can vary between lenders, due to diverse experience levels and shifting internal processes. Working with an experienced lender can help mitigate risks for all parties involved.

How to get started.

Companies that wish to pursue ABL typically start by determining how much capital they need for a particular business-related goal, such as payroll, acquiring new assets, or scaling up. These prospective borrowers also identify any potential assets they can offer as collateral based on the desired amount necessary to reach the targeted goal. With this in mind, the borrowing business contacts numerous lenders to determine the best terms available.

Once the company has located a lender, it must fill out the necessary paperwork and identify the collateralized assets. The lender will then evaluate these assets based on individual processes to create a lending package for the borrower. While lenders typically assess a company’s risk based on their overall health, they may also calculate a loan-to-value ratio based on the value of the asset divided by the desired loan amount.

During negotiations, lenders and borrowers finalize the terms of the agreement, which include interest rates, repayment schedules, and other critical details. When all parties are in agreement, the funds are disbursed as described in the terms. Timelines vary, but disbursements are typically either a lump sum or a revolving line of credit.

Asset-based financing vs. other financing solutions.

In addition to asset-based lending, companies also have access to traditional bank loans and cash-flow financing. Both options offer advantages and drawbacks, depending on how they integrate with your company’s current state and future goals. Explore the differences between ABL and traditional bank loans or cash-flow financing below.

ABL vs. traditional bank loan.

With a traditional bank loan, a financial institution determines loan eligibility based on a company’s profitability, creditworthiness, and time in business — many of the common requirements for standard business loans. There’s no collateral required unless the lender mentions it in the terms and conditions. Companies can increase their chances of approval by building strong credit, demonstrating longevity in business, and maintaining a healthy and consistent cash flow to support repayment.

However, traditional bank loans usually come with a longer approval process. Depending on market conditions, interest rates may be lower or higher for traditional bank loans than asset-based loan agreements. A traditional bank loan also has less strict financial monitoring requirements.

Traditional bank loan amounts vary based on the lender’s perceived risk, which often translates to less flexibility in loan terms. In addition, companies may also be restricted to certain funding types — like term loans or lines of credit — based on the lender’s risk evaluation.

ABL vs. cash-flow financing.

Cash-flow financing involves securing a loan based on a company’s projected cash flow, which can be risky due to the fluctuations inherent in a company’s profit. This type of financing is frequently available in term loans, but less often in revolving lines of credit because it’s most often unsecured. Similar to traditional loans, cash-flow financing doesn’t subject borrowers to the same financial oversight as ABL.

Middle market companies typically work with a single lender for cash-flow financing, rather than maximizing the potential of working with multiple lenders to leverage numerous assets and capitalize on business competition. In addition, cash-flow financing involves stricter eligibility requirements because loans are underwritten by expected profits instead of those realized by the company. Cash-flow financing is geared more toward businesses that may lack significant tangible or liquid assets but have strong projected earnings.

Take the next step in asset-based lending.

Unlock your company’s potential with asset-based lending solutions designed for middle market companies with scaling in mind. Work with an experienced lender that recognizes the full value of your company’s assets so you can capitalize on lucrative opportunities and catapult your business to success. Connect with a Middle Market Relationship Manager today to learn more about how we can help your company.