Asset Based Loan Fit
“When Does It Make Sense To Take Out An Asset Based Loan?”
We are in a period of time where asset based loans have grown in significance due to the more conservative approach currently being taken by banks and institutional lenders.
In most cases, Asset Based lending is significantly more expensive than bank or institutional lending, reflecting the higher level of risk inherent in the business being financed. With greater cash flow comes lower cost forms of asset based lending as well, but for the purposes of this discussion, I’m referring to asset based lending that falls in the 18% to 24% per annum type rate range.
Any business owner will tell you that you can’t function long term on those types of rates and for the most part, they are absolutely correct.
The higher priced, and more traditional form of asset based lending is meant to be short term in nature, dealing with either distress or growth.
In a distress situation where the business is failing, gone through a down turn in the market, or has been unceremoniously dumped by its institutional lender for some reason, an asset based financing facility buys time to either turn things around, wind down, or sell off in a manner that does not destroy value or equity in the process.
For situations of growth, if the growth rate is too high, especially for newer businesses or smaller scale businesses, banks and institutional lenders will shy away from business financing these situations due to risk of the business not being able to properly scale growth and crashing and burning at some point along the way to a better top and bottom line. Once higher levels of sales are maintained over a period of time, then lower cost forms of money will be more than happy to step in and take over the business. They just don’t have the stomach for the potential wild ride that may occur during a growth spurt.
Neither a growth or distress situation can be sustained for any length of time which is why the asset based financing can be a very good fit, even at significantly higher rates of interest than what can be secured through an institutional lender.
In situations where the business is asset intensive and needs a high level of financing leverage over the long term, an asset based financing solution can still work, but its going to have to be a lower cost version which tends to require a minimum facility size of $5,000,000 and strong cash flows and margins to support a lower cost of funds.