Asset Financing: Definition, How It Works, Benefits and Downsides

What is asset financing?

Asset financing lets a company borrow money by pledging its balance-sheet assets—such as accounts receivable, inventory, machinery, buildings, or short-term investments—as security for a loan. The lender takes a security interest in the pledged assets and can seize and sell them if the borrower defaults.

How it works

• The borrower identifies assets to pledge (commonly accounts receivable or inventory; using inventory is often called warehouse financing).
• The lender evaluates the assets and advances funds based on their value.
• The loan agreement typically creates a security interest in the pledged assets and may include covenants restricting the borrower from using those assets to secure other loans.
• If the borrower fails to repay, the lender may seize and sell the collateral to recoup the loan.

Asset financing is generally used for short-term cash needs or working capital—paying wages, buying raw materials, or covering temporary cash-flow shortfalls—rather than for financing long-term projects.

Asset financing vs. asset-based lending

These terms are closely related and often used interchangeably. A key distinction in common usage:
* Asset-based lending often describes loans where the purchased asset (e.g., a car or house) serves directly as collateral.
* Asset financing more broadly describes borrowing against a company’s existing assets. Loan contracts may include covenants that prevent the borrower from using pledged assets as collateral for other loans.

In both cases, failure to repay can result in seizure and sale of collateral.

Secured vs. unsecured loans in asset financing

• Secured loans: The borrower pledges specific assets as collateral. Because the lender has recourse to those assets, these loans usually carry lower interest rates and higher recovery priority in bankruptcy.
• Unsecured loans: No specific collateral is pledged, though the lender may retain a general claim on the company’s assets if repayment fails. Unsecured loans typically have higher interest rates and lower priority in liquidation.

Benefits

• Faster access to cash compared with lengthy project- or credit-based lending processes.
• Accessibility for small companies, startups, or businesses with limited credit histories—lenders focus on asset value rather than overall credit rating.
• Flexible use for short-term working capital needs.

Downsides

• Risk of losing pledged assets if the borrower defaults.
• Loan covenants can limit a company’s flexibility to use assets for other financing.
• Unsecured options, when available, usually cost more in interest and offer less protection to the borrower in insolvency situations.
• Typically better suited for short-term needs rather than long-term financing.

Key takeaways

• Asset financing uses a company’s assets as collateral to secure loans, commonly for short-term working capital.
• It provides quicker access to cash and can be more accessible to firms with weaker credit histories.
• Secured loans based on assets generally offer lower interest rates but expose the borrower to asset repossession on default.
• Loan agreements may include covenants that restrict further use of pledged assets.