Understanding Asset-Based Lending for SMEs
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In the fast-paced world of small and medium-sized enterprises (SMEs), securing the right type of finance can be a game-changer. Traditional bank loans often require lengthy approval processes and stringent criteria, which can be a hurdle for many growing businesses. This is where asset-based lending (ABL) comes into play — offering a flexible, accessible, and often quicker alternative for SMEs seeking to fuel their ambitions.
What is Asset-based lending?
Asset-based lending is a business financing method that uses an asset owned by a business as security against a business loan. The lenders evaluate assets such as inventory, accounts receivable, property, or industrial equipment to determine whether a business is eligible for finance. Some lenders will even consider assets such as intellectual property like brands and patents, when making a lending decision. The loan amount that a lender is willing to offer a qualifying business is significantly influenced by the value of the asset provided as collateral, among other factors. This form of lending diverges from other financial solutions, such as unsecured loans, where lenders may place higher emphasis on your company’s balance sheet, profitability, and working capital.
For businesses navigating unpredictable markets or those grappling with inconsistent cash flow, asset-based lending could present a viable alternative financing option.
How Does Asset-Based Lending Work?
The process begins with an assessment of the company’s assets by the lender. Typically, the lender will value assets such as unpaid invoices, stock, or machinery, and offer a loan or credit facility based on a percentage of that value — often ranging from 70% to 90% for receivables, and slightly less for inventory or equipment. As the business repays the loan or as assets fluctuate in value, the size of the facility can adjust accordingly, providing ongoing flexibility.
Who Uses Asset-Based Lending in the UK?
ABL is popular among manufacturers, wholesalers, and retailers, particularly in sectors like construction, logistics, and retail, where assets like inventory and receivables are significant. It’s also used in restructuring or insolvency scenarios to stabilise cash flow.
What assets can be used for asset-based lending?
A wide variety of assets on a business’s balance sheet could be used as security for asset-based finance.
This includes physical assets such as:
- debtors
- stock
- equipment
- machinery
- property
It can also include intangible assets such as intellectual property (IP).
What do I need to consider before using asset-based lending?
Here are some important questions you’ll need to consider before proceeding with borrowing from an asset-based lender:
- How long is the borrowing period?
- What is the interest rate on the facility?
- What is the advance rate against the various assets?
- How much will I pay for the finance facility in the long run?
- Are there charges for early repayment?
ABL offers several advantages for UK businesses:
- Growth Support: ABL can fund acquisitions, expansions, or working capital needs, enabling businesses to scale without diluting equity.
- Speed: Funds can be accessed quickly, often within weeks, as the focus is on asset appraisal rather than extensive financial due diligence.
- Accessibility: There is a large ABL market in the UK from high street banks to alternative ABL providers. This competition makes ABL facilities highly accessible to businesses throughout the UK.
- Flexibility: The revolving nature of ABL allows businesses to borrow as needed, aligning with operational cycles, seasonal demands, or growth opportunities.
Types of Asset-Based Lending
- Invoice Financing: Advances money against outstanding invoices, helping to mitigate cash flow gaps caused by slow-paying customers.
- Inventory Finance: Uses unsold stock as collateral, freeing up funds tied up in inventory.
- Equipment Loans: Leverages owned machinery or vehicles to secure funding.
- Property-Backed Loans: Utilises owned property or real estate as security for larger borrowing needs.
Benefits for SMEs
- Improved Cash Flow: Quick access to capital helps smooth out cash flow challenges, especially for businesses with seasonal sales or long payment cycles.
- Flexible Funding: Facilities can grow with your business, as the value of assets increases.
- Faster Approvals: Asset-based lending often has a simpler, quicker approval process than unsecured loans.
- Retain Control: Unlike equity finance, ABL doesn’t dilute ownership or control of the business.
Considerations and Risks
While asset-based lending offers many advantages, it’s important to weigh up the potential risks:
- If your business is unable to repay the loan, the lender can seize and sell the collateralised assets.
- The value of assets may fluctuate, affecting the amount you can borrow.
- There may be fees associated with setting up and maintaining the facility.
It’s crucial for SMEs to fully understand the terms of any asset-based facility and seek professional advice where needed.
Is Asset-Based Lending Right for Your SME?
If your business is asset-rich but cash-poor, or if you’re looking for a funding solution that grows alongside your operations, asset-based lending could be a strategic option. It’s particularly suitable for companies in manufacturing, wholesale, distribution, and other sectors with substantial tangible assets.
An integrated approach
Crucially, ABL doesn’t have to be a standalone arrangement. It can be combined with traditional cash flow-based lending in a single structure. This integrated approach can have significant advantages. Both borrower and lender can benefit from a single banking relationship – avoiding the many problems that can arise when a lending structure involves a mix of creditors. Essentially, the borrower benefits from a stable relationship and reliable cash flows while the lender benefits from greater oversight and security.
Besides addressing working capital needs, a combined ABL/cashflow structure can be used for acquisition finance – an aspect of ABL that is perhaps less well understood than it ought to be. As with any ABL arrangement, much depends on the nature of the businesses in question. However, for companies with substantial assets, a blended ABL/cashflow approach can be an excellent cost-effective option.
