Asset-Based Lending

What is asset-based lending?

Asset-based lending (ABL) is a business financing method in which a loan or line of credit is secured by the borrower’s assets—commonly accounts receivable, inventory, equipment, real estate, or marketable securities. It’s often used by small and mid-sized companies that need short-term liquidity but cannot obtain traditional unsecured credit because of limited cash flow or credit history.

How it works

• Collateral and advance rates: Lenders evaluate and value the pledged assets, then advance a percentage of that value (the advance rate). Highly liquid assets command higher advance rates; less liquid physical assets yield lower advance rates.
• Loan-to-value examples: Marketable securities might support an advance of around 80–85% of value, while equipment or real estate typically support a much lower percentage (for example, around 50%).
• Documentation and covenants: Loans commonly include covenants such as negative pledge clauses that prevent the borrower from reusing pledged assets for other financing. Lenders may also require regular reporting, audits, inventory counts, or field exams to monitor collateral.
• Pricing and risk: Because collateral reduces lender risk, interest rates on asset-based loans are usually lower than on unsecured loans. However, loans secured by less liquid physical assets are treated as riskier, resulting in lower advances and potentially stricter terms.

Example

A company needs $200,000 to expand. If it pledges $200,000 of marketable securities and the lender’s advance rate is 85%, the borrower can receive $170,000. If the same company instead pledges less liquid equipment or real estate, the lender might offer only 50% of the asset value—or $100,000—because of conversion costs and potential market-value declines.

Who uses asset-based lending

• Small and mid-sized businesses with valuable physical assets or receivables are the most common borrowers.
• Larger companies may use ABL for urgent, short-term needs when issuing equity or bonds would be slow or costly—examples include time-sensitive acquisitions or unexpected capital expenditures.

Key considerations for borrowers

• Collateral choice matters: More liquid assets yield better borrowing terms.
• Covenants and restrictions: Negative pledge clauses and other covenants can limit how you use or re-pledge assets.
• Monitoring and compliance: Expect ongoing reporting and possible audits; failure to comply can trigger default.
• Cost vs speed: ABL can be faster than public financing but involves relinquishing control over pledged assets if you default.

Pros and cons

Pros
* Access to capital for firms with limited cash flow or credit.
* Lower interest rates than unsecured borrowing because of collateral.
* Faster than issuing equity or bonds for urgent needs.

Cons
* Lower advance rates for illiquid assets.
* Potential restrictions on business operations through covenants.
* Risk of losing pledged assets if the borrower defaults.

Bottom line

Asset-based lending is a practical financing option for businesses that can pledge inventory, receivables, equipment, or securities. It provides flexible, often faster capital access with lower interest rates than unsecured debt, but borrowers should carefully weigh advance rates, covenants, monitoring requirements, and the risk of losing collateral before proceeding.