5 Major Differences Between Asset-Based Lending And Other Types Of Financing?

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What Are Factoring And Asset-Based Lending?

Invoice factoring is a financing method in which a factoring company buys accounts receivable in exchange for immediate cash (payment). Factoring helps businesses experiencing cash flow issues because they cannot wait months for customers to pay invoices. While factoring transactions often resemble a line of credit, they are more structured as a sale. For each invoice purchase, you and the finance company will go through a purchase agreement. As part of the purchasing process, the factoring company notifies the payer (your customer) of the purchase and verifies the invoice's validity. Invoice factoring requires no credit checks to qualify. Many sectors use this type of financing. For example, factoring companies usually offer government contract factoring, staffing factoring, and manufacturing financing. 

On the other hand, an asset-based loan (ABL) is a loan or line of credit secured using company assets as collateral. The collateral used for this type of financing includes accounts receivable and equipment, inventory, and other assets. Many asset-based loans are structured as lines of credit. They allow the company to access funds to pay business expenses or make new investments. The lender will use the assets' established value to determine the borrowing base, which is the sum of money you can borrow. The borrowing base is a percentage of the market value of the assets. ABL lenders often offer a loan-to-value ratio of 75% to 90% for accounts receivable. Other collateral, such as equipment or inventory, is financed at a lower loan-to-value ratio, usually 50% or less.

Factoring is a kind of asset-based financing that is commonly confused with asset-based lending. While these solutions have some similarities, they are very different. The following comparison will help you understand the differences between these products and help you determine which one will be the best for your business.

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Some Differences When Comparing Asset-Based Lending And Invoice Factoring

Asset-based loans and factoring services can look similar because both programs can provide comparable benefits. However, these products have significant differences to be aware of:

1. Risk —  Factoring is available to new and growing companies that are not eligible for traditional bank financing. Because of this, factoring is considered a riskier form of funding for the lender. On the other hand, asset-based loans are only for larger and more established companies. While these companies still struggle to qualify for bank financing, they are well on their way to being "bankable."
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2. Size —  Most asset-based loans start with a borrowing base of $700k and can go up to a few million. On the other hand, factoring financing lines have no minimums and can work with startups and small businesses.
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3. Cost - Generally, asset-based loans are considerably cheaper than invoice factoring. The price of a factoring line is established by discounting the total value of the invoice by a percentage. Discounts can range from 0.69% to 1.59% per 30 days. On the other hand, asset-based loan prices are calculated at an annual percentage rate. This annual percentage on ABL's can range from 7% to 15%, and many variables, such as line size and risk, can impact the final costs.
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4. Discretion- Because the factoring company owns your invoices, they will be the ones contacting your customer for payment. Suppose an invoice isn't paid by the due date. In that case, your customer can expect a follow-up call from the third-party lender inquiring about the payment. In addition, factoring companies generally will require that your customer make checks payable directly to them. When working with asset-based loans, the lender will not contact your customers, and they will not know about the lender's involvement. As a result, your business will continue to handle the collections of your receivables and retain a vital relationship with your customers.
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5. Due diligence - Most factoring facilities do with minimal due diligence. Usually, the factoring company reviews a client's financials and conducts a collateral search. This review is often done in a day or two and is not expensive.

Due to their structure and larger size, asset-based loans require that the lending companies conduct a more substantial due diligence. Lenders will perform audits and collateral checks to review the accounting records. Most lenders charge a few thousand dollars for this process, though costs can vary.

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Which Option Is The Right Financial Solution For Your Company?

Most businesses prefer to use asset-based loans over factoring due to their overall cost and flexibility. Still, asset-based loans typically have high due diligence costs and are available only to companies that meet their collateral requirements and size. On the contrary, factoring is available to companies of all sizes, has minimal due diligence costs, and is easier to get.

Asset-Based Lending vs. Traditional Bank Loans

ABL provides a more flexible approach to financing a business's current operations and needs for future growth. In contrast to conventional bank lending, where a long list of requirements needs to be fulfilled, asset-based loans are based on the collateral set for the loan. The most typical type of ABL uses the business's accounts receivables. When financing accounts receivables, 1st Commercial Credit will advance funds to the borrowing business based on the value of the receivables submitted. 

Advance rates are different depending on the industry and the risk associated with it. Your customers will submit payment to us. When the funds are collected in full, the lender provides the remaining balance to the borrower after deducting the fees it charges for the loan and managing the collections process.

Asset-based lenders can also lend against other types of assets, including inventory, real estate, and equipment. Nonetheless, receivables are frequently the most significant proportion of collateral companies use for these loans, mainly because of their greater liquidity.

The Lending Process For Asset-Based Lending

To qualify for asset-based lending, lenders will focus on the collateral quality and not on the borrower's credit rating or cash flow. They evaluate the creditor's ability to pay and determine their creditworthiness. 

Traditional bank lenders are limited by internal bank lending standards and strict requirements. In most cases, banks will not lend to companies that have unbalanced debt-to-capital ratios. In contrast, asset-based lenders are not subject to such constraints, giving them the freedom to finance many small businesses that otherwise do not meet traditional bank lending standards.

Benefits of ABL To The Borrower

There are many advantages for borrowers associated with asset-based loans. ABL provides quick and ongoing cash flow liquidity for a company's working capital. Access to this money will allow a business to purchase materials and supplies, meet payroll and other operating expenses and keep their accounts payable current. 

In addition, the bank's lending process may be lengthy and challenging. Another plus associated with ABL loans is that since they are based on collateral, lenders are more inclined to be much more flexible and work with a borrower during financial difficulty when their finances are not doing great.