What are Asset-Based Loans?
Asset-based loans involve something physical (an asset) that is used as collateral for the loan. For most companies, it is inventory or accounts receivable that act as the collateral. In a sense, the opportunity for future revenue (namely, when it comes to inventory used as collateral) is cut off so that the company can get a lump sum of money in the present.
Lenders who offer asset-based loans meet with the company, settle on the loan terms, and lend a percentage of the total value of the collateral that is being used. For receivables, the percentages are commonly somewhere around 80% of the value. With completed inventory, the percentage is typically about 50% of the inventory’s value. Whatever that percentage translates to in dollars is the amount that the borrower receives.
Asset-based loans are an alternative way for a company or individual to get financing.
Asset-based loans use physical assets (often inventory or receivables) to secure a loan that is a percentage of the assets’ value.
- Hard money loans are a type of asset-based loan.
- Asset-based loans are risky for both lenders and borrowers. The lender must check the assets’ value carefully so as not to give a loan that can’t be recouped; the borrower may lose their collateral (assets) if they default or can’t repay the loan.
Security for Asset-Based Lenders
The assets used as collateral for an asset-based loan are – particularly for the lender – supposed to be valuable. It means that they are truly worth the market value that the lender uses to determine the percentage that is given as the loan. If the borrower subsequently defaults on the loan, the lender is secured with knowing it can seize the assets that serve as loan collateral.
Once seized, the lender can then liquidate the assets and recover the amount it paid out as the loan. It is why asset-based lenders look closely at the assets being offered as collateral; that is, the lender’s primary focus. If the borrower is in any way unable to repay the loan, the assets can be used to secure a return of the loan amount to the lender.
Hard Money Loans vs. Asset-Based Loans
Hard money loans and asset-based loans are almost always talked about at the same time. The differences between the two are discussed below.
Hard money loans are an alternative to traditional loans and far easier to secure. They do, however, come with incredibly high interest rates and are an extremely risky way to get money. Real estate investors tend to prefer hard money loans because they use real estate as collateral for the loan.
Actually, hard money loans are a form of asset-based lending because they use something physical as collateral. As mentioned above, hard money loans use large pieces of property, while asset-based loans use other assets (inventory and receivables).
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: