Asset-Backed Loan
Asset-backed lenders provide capital to an organization that already has a resource that can be converted into cash
The loan is then secured by that asset, which means that if the loan is not repaid the lender takes the asset
Asset-backed loans vs. asset-backed securities
Asset-Backed Loans are not the same things as Asset-Backed Securities, which are pools of loans that are packaged and sold to investors as securities which became infamous in the financial crisis of 2008.
Asset-Backed Loans are different from other types of debt that unsecured, meaning they are not backed by assets, like credit card debt, or revenue finance debt, or convertible debt. Essentially, those other types of debt have different payment periods, terms, and interest rates because they are no underlying assets providing collateral for the loan.
Asset-backed loans vs. credit card finance
One of the most common types of finance for early stage organizations is personal credit cards, or business credit card debt. This type of debt is typically expensive in the long run with extremely high interest rates because it is not attached to an underlying asset, also known as an unsecured loan.
Loans for assets like accounts receivable, inventory, marketable securities, and property, plant and equipment (PP&E) like a new robot. These loan terms are more favorable than credit card debt, but less favorable than traditional loans. Their terms are determined by the value of the underlying asset should you fail to repay. The lender will then take ownership of your asset and convert it into cash.
Yet asset-backed loans are not a viable option for the earliest stage organizations because of the chicken-egg problem. You can’t get an asset-backed loans if you have no assets, and you can’t purchase assets unless you have capital. As a result, asset-backed loans are only used by companies that already have starting capital.
Example Firms
CIT | Foothill | Great Rock | JP Morgan Chase | PNC Bank | Wells Fargo | White Oak
Are asset-backed loans the right capital for your business at this stage?
COMPANY PERSPECTIVE
Benefits
- Asset-based loans are easier and quicker to obtain than unsecured loans and lines of credit
- Helps to finance capital expenses that are not easily financed through day-to-day operations
- Lower interest rates than unsecured loans
- Non dilutive
Challenges
- Requires additional fees like audit fees and diligence fees
- Just like in the game of Monopoly, lenders tend to discount the value of the asset when pricing the loan
- If you fail to repay, you stand to lose assets
Key Performance Indicators
- Interest rate
- Payback period
- Value of asset
- Audit and diligence fees
CAPITAL GIVER PERSPECTIVE
Benefits
- Asset-backed loans are safer when the underlying asset has cash value
- If the borrower defaults, the lender takes ownership of the asset and can liquidate and settle the amount outstanding
- High rate of return vs. conventional bank loan
Challenges
- Requires assets that are more liquid, meaning that there is a market for the asset to be liquidated into cash
- The lender will need you to do regular monitoring of the condition of the collateral
- If value in the underlying asset appreciate, the lender cannot change the loan structure during the term of the loan
Key Performance Indicators
- Loan to Value Ratio (LTV = Loan Amount / Asset Value)
When it Works Well
Better terms than alternatives
Asset-backed loans work well when the asset has a fair value and price and the borrower receives terms that are favorable to other debt options, with lower interest rates and favorable repayment terms.
Common in industry
These loans work well when the asset is not considered particularly exotic or unique to an industry, and there is a market for liquidating the underlying asset so that the borrower is given fair terms.
Helps cash flow
Asset-backed loans are used for different reasons and for companies in good financail situations and difficult situations as well. In either case the asset-backed loan can help the company over a cash flow hump or help to smooth expenses to be more closely in line with cash flow.
Challenges to Asset-Backed Loan Finance
Invasive reporting requirements
Some asset-backed loans require lenders to monitor the asset frequently and ask the company to give what are sometimes considered invasive reports.
Lenders may trade off loans with minimal constraints, or covenants, with high touch monitoring, vs. lower constraints with less monitoring.
The link to asset-backed securities
Before the Financial Crisis, non-bank lenders satisfied the demand for asset-backed loans, also fueling the asset securitization market, as non-bank lenders would package and sell their loans to banks.
We now know that over valuation of asset-backed securities lead to the financial meltdown in 2008. The background of this crisis continues to shape and structure the Asset-Backed Lending industry and borrowers should remain vigilant if you feel you are getting to good of a deal – make sure you read all of the terms.
Denied standard loans
Most small businesses are denied standard bank loans when they are just starting out or running into cash flow issues. Asset-backed loans are often a last resort for small and medium-sized businesses with poor credit ratings.
When faced with the dilemma of trying to meet payroll during a busy season, some turn to asset-based lending to get out of a cash crunch, and may end up accepting unfavorable terms.
A secured loan can be a signal that your company’s financial position is not strong and this may adversely affect how investors and lenders evaluate your company.
Trends in Asset-Backed Loan Finance
Bank vs. non-bank lenders
Before the Financial Crisis, non-bank lenders satisfied the demand for asset-backed loans, also fueling the asset securitization market, as non-bank lenders would package and sell their loans to banks.
The collapse of the securitization markets enabled banks to build Asset-Backed Lending as a product, but the non-bank version were able to provide cheaper and more flexible loans.
In many countries, banks are limited in what they can finance and may not be permitted to finance assets like heavy equipment and machinery, for example, leaving room for non-bank lenders.
Use in low-income countries
Asset-Backed Loans are used to provide financing in low income countries to support energy transition, such as the Bill & Melinda Gates Foundation investing in the financing of last mile solar for companies like M-KOPA.
M-KOPA groups customers together, to create a less risky asset-backed lending pool. While other types of financial arrangements have proliferated in low income countries, the use of asset-backed securities pointed to a large creditable market to finance energy, and telecommunications services.
Competition from fintech
New types of FinTech companies that sell through market places are starting to design less secure financial instruments that develop algorithms for underwriting and risk management.
For the four out of five small businesses who who are denied a typical bank loan, they may choose to seek out FinTech options for their speed and ease of decision-making despite much higher interest rates provided in Asset-Backed Loans.
Before You Consider Asset-Backed Loan Finance
- Do you have assets on your balance sheet like property, plan or equipment, or receivables? You’ll need it!
- Do you have operational rigor to predictably pay off the principle and interest?
- Will your projected cash flows pay off the loan? You’ll want to have enough cash, otherwise you are at risk for having the asset seized.
Exploring Asset-Backed Loans
- Take a look at regional banks who may have a better understanding if your sector is regional, and compare to loan terms you would get from a more national bank
- Compare the actual capital cost for asset-backed loans to credit card debt or Revenue Based Finance.
- Plan out your funding and capitalization strategy to figure out if Asset-Backed Loans are right for you.
Discover Alternative Capital
Asset-Based Loans are one way to grow your company, and you can choose other capital types as an alternative or pair and combine at different stages of your business. Consider these alternative capital sources or explore our Capital Library.
