Asset based lending
An Asset Based Loan (ABL) is a loan or line of credit that is secured using company assets as collateral. The collateral used for security often includes accounts receivable, inventory and equity equipment. This is quite appealing to clients as they are not securing personal assets such as the family home to fund working capital requirements for their business. Most asset based loans are structured as lines of credit. The lender uses the value of the assets to determine a borrowing base – essentially the amount of money you can borrow. The borrowing base is usually a percentage of the market value of these assets. ABL lenders often provide a loan-value-ratio (LVR) ratio of 70% to 90% for accounts receivable. Other collateral, such as inventory or equipment, is financed at a lower LVR, usually 50% or less, depending on method of valuation. The borrowing base is updated regularly to reflect changes in asset values.
Asset based loans have a number of advantages and are provided to small businesses that are well established and have tangible assets.
Factoring or Debtor/Invoice Finance
Invoice factoring is a type of business financing in which a factoring company (eg Scottish Pacific/Bibby) purchases accounts receivable in exchange for an immediate payment, generally around 80% of the face value of the ledger, less their costs. Factoring helps companies that have cash flow problems because they cannot wait the usual 30 to 90 days for customers to pay invoices.
While factoring transactions can resemble the function of a line of credit, they are often structured as an actual sale. The finance company purchases each invoice through a purchase and sale agreement. As part of the purchasing process, the finance company notifies the clients customer of the purchase and verifies the accuracy/integrity of the invoice with the customer.
This can be a negative for the client.
Differences between factoring and an asset based loan
On the surface, asset based loans and factoring facilities can look and behave similarly because both can provide similar benefits. However, there are important differences.
Factoring is generally provided to new and growing companies who normally cannot qualify for conventional bank financing. Consequently, factoring is considered a riskier form of financing from the lender’s perspective.
Asset based loans, on the other hand, are provided to more established companies. While these companies still may not qualify for bank financing, they are well on their way to being “bankable.”
Cost is one important difference between these products. Generally, asset based loans are cheaper than factoring facilities. Factoring facilities generally split fee facility where an administration charge (0.50% to 2.50%) charged on the face value of the invoice and interest (10% to 24%) charged on funds drawn.
Asset based loans are priced with an annual percentage rate which can range from 8% to 15%. However, many variables, such as risk, facility size covenant penalties which can impact on the final costs.
Customer contact and interactions
Disclosed factoring facilities require a high level of interaction between the factoring company and the customer paying the invoice. As mentioned before, customers are notified and invoices are verified regularly to ensure that the invoices being purchased are accurate. Consequently, the clients customers will know they are using accounts receivable factoring. This aspect of factoring is not necessarily a problem however as stated above clients do get funny about a third party contacting their customers.
Asset based lenders don’t have any substantial contact with your customers. They may verify some invoices, but, usually, your customers will not know you are using the facility.
Similarities between factoring and asset based lending
One important similarity between these products is how customer payments are handled. Since accounts receivable are the main collateral backing both transactions types, customers mail payments to a bank account controlled by the lender. Customer payments are used to settle the transactions.
Note that payments sent can be made in the client’s name.
Consequently, it does not necessarily alert the clients customers they are using an ABL or a factoring facility.
Which product is most suitable
Most companies prefer to use Asset Based Loans over factoring due to the flexibility with a wider asset base to borrow against.
Alternatively, factoring is available to companies of all sizes, has minimal due diligence costs, and is relatively easy to get.