What is Asset-Based Finance?

Asset-based finance is a specialized method of providing companies with working capital and term loans that use accounts receivable, inventory, machinery, equipment and real estate as collateral. It is essentially any loan to a company secured by one of the company's assets.

Asset-based funding is often used to pay for expenses when there are gaps in a company's cash flows, but can also be used for startup company financing, refinancing existing loans, financing growth, mergers and acquisitions, and for management buy-outs (MBOs) and buy-ins (MBIs).

Asset-based finance may also be called asset-based lending or commercial finance.

How Asset-Based Finance Works

An example of asset-based finance would be purchase order financing; this may be attractive to a company that has stretched its credit limits with vendors and has reached its lending capacity at the bank. The inability to finance raw materials to fill all orders would leave a company operating under capacity and could put the company at risk for closure.

Key Takeaways

  • Asset-based financing is a way for companies to use property, inventory, and accounts receivable as collateral to obtain a loan. 
  • Asset-based finance is a field solely used by businesses not by individuals seeking personal loans.
  • These types of loans may be more flexible than traditional commercial loans.
  • Other names for the asset-based finance industry are commercial finance and asset-based lending.
  • Asset-based loan financing may be used by companies that need short-term working capital to keep day-to-day operations, like payroll, for example, up and running.

The asset-based lender finances the purchase of the raw material, and the purchase orders are then assigned to the lender. After the orders are filled, payment is made to the lender, and the lender then deducts its cost and fees and remits the balance to the company. The disadvantage of this type of financing, however, is the interest typically charged—which can be as high as prime plus 10%.

However, these loans do have lower interest rates than unsecured loans, because of the loan's collateral that allows the lender to recoup any losses if the borrower defaults.

Asset-Based Lending

Asset-based loans are agreements that secure the loan via collateral, like equipment or property owned by the borrower. Asset-based lending may be a line of credit, other than a cash-funded loan, but either way, the loan money is secured by inventory or accounts receivable—some sort of collateral from the borrower's business or properties.

The most frequent users of asset-based borrowing are small and mid-sized companies that are stable and that have physical assets of value. However, larger corporations do use asset-based loans from time to time, usually to cover short-term cash needs.

Asset-based finance lenders tend to favor liquid collateral that can be easily turned to cash if a default on the loan occurs. Physical assets, like machinery, property, or even inventory, may be less desirable for lenders. When it comes to providing an asset-based loan, lenders prefer companies with not only strong assets but also well-balanced accounts.