What Is Asset-Light Debt?
Asset-light debt is a form of corporate debt where the amount of collateral is below typical standards. A company may not have the assets to post as collateral for a loan and may seek out cash flow financing, using their cash flow to qualify for a loan. This leaves the loan secured with little or no assets.
- Asset-light debt is corporate debt secured with little to no collateral.
- This type of debt may exist when a company does not have the assets to post as collateral for a loan.
- In this case, a company may use their cash flow, or dividends, to qualify for a loan.
Understanding Asset-Light Debt
Asset-light debt is issued with little to no collateral. A borrower may instead use their credit quality or steady earnings to show their ability to pay. However, asset-light debt is risky for businesses because if there is a downturn in the market and their revenues drop, they may find themselves unable to service their loans and facing bankruptcy.
Companies may have a largely asset-light debt structure, or seek an asset-light loan, for a number of reasons. Those with asset-light debt generally rely on their cash flows to qualify for loans. Asset-light debt also requires the borrower to have better credit quality than asset-backed loans and steady earnings.
Companies using asset-light debt can be holding companies. These companies own virtually no assets, or just one specific asset, and are formed for the specific purpose of servicing a loan. In typical asset-light cases, that purpose might be to hold the debt of a parent company. In that case, the company might have zero assets and a loan.
Asset-Light Debt Example
Banks and lenders generally require a company to put an asset up as collateral for the loan. This secures the loan so that in the event of default, the bank can use the asset to cover a portion of the loan loss.
For example, a bank generally offers a loan that’s 70% of the value of the collateral. Company ABC uses a $100,000 piece of equipment to secure a $70,000 loan. If the bank has to repossess the equipment, there is enough value to cover the loan balance even if they have to resale it at a discount.
In the case of asset-light debt, the bank may accept a smaller amount of collateral and take into consideration the company’s free cash flow. For example, Holding Company ABC has a $200,000 loan but $10,000 in assets. The parent company’s promised cash flows, or dividends, to the holding company are used instead to secure the loan. The use of this asset-light debt structure helps insulate the parent company should the loan become unserviceable. Special purpose vehicles (SPVs) can be asset-light, acting as a way to finance assets with little collateral or equity.