When small companies lag behind cash coming in and spending cash, they can use collateral to obtain the necessary funds for short-term needs, such as paying employees and buying raw materials. Asset-based issuers only accept certain types of assets as collateral and have special requirements. Assess eligible assets that can be used as collateral and best practices when searching for asset-based loans.
Eligible assets for collateral in asset-based loans
Lenders accept debtors; high-quality balance sheet items such as production equipment and trucks; and product inventory as collateral for asset-based loans. Each asset type offers the borrower different advantages and disadvantages.
Small business owners can only use their debtors of the highest quality, often those of less than 60 to 90 days, as collateral for asset-based loans. Lenders value debtors with a 20 to 30% discount on the actual value. In the event that a borrower defaults on his asset-based loan, the lower value creditor can set off the claims with a discount, encourage a faster payment and still make a profit.
A disadvantage of using some of your most liquid assets as collateral is that you could end up in a larger money crisis if those funds are seized by your lender. Another drawback is that the bank can request updated financial statements, including projections for upcoming quarters or fiscal years, to make a final decision.
Production equipment and trucks
Unlike debtors, production equipment and industrial vehicles are valued at less than 70% of their actual value. Lenders must take into account additional costs and challenges. When there is a very limited pool of potential buyers for a specific machine or vehicle, the financial institution that provides the loan may have reduced the bargaining power. The lender may need additional assessments to better understand the actual market value of the asset and include the cost of those appraisals in the loan reimbursement schedule. In the event that a liquidation of the asset does not cover the full balance of the loan, the entrepreneur is still liable for the remaining debt.
Whether raw materials or finished goods, inventories have the lowest valuation from the potential assets that can be used as collateral for a loan. Depending on their size, stocks may require storage space, climate control and security. Lenders assess eligible stocks at around half their market value. When using inventory or other assets as collateral, a business owner must often insure and value the assets. To reduce exposure to risk, a lender may have additional requirements for issuing an asset-based loan.
Practical tips when searching for asset-based loans
Small businesses that have just started or have a limited history of business loans can use asset-based loans as a solution to finance their cash needs in the short term. It does not matter which of the three types of collateral a business owner intends to use, he must have his financial statements in order and up-to-date.
By anticipating all potential requirements of a lender, such as appraisals, insurance policies and settlement history of claims, a business owner increases his chances of obtaining an asset-based loan. Consider all of your available financing options before signing up for asset-based loans. In 2012, only one in three small business owners had their actual business credit score, according to a March survey of 889 small businesses by The Wall Street Journal and Vistage International, a San Diego-based executive mentoring group. A secured loan is preferable to an unsecured loan and allows business owners to strengthen their business credit scores.
The bottom line
Getting short-term financing is possible with the right collateral. Pay attention to the requirements for each type of collateral and prepare accordingly. Although asset-based lending has some intrinsic risks, it can provide much-needed capital to emerge from a cash crunch and increase business revenue.