Asset-Based Financing - Cost and Considerations
There are a variety of financial tools available to the savvy business person and entrepreneur. Asset based financing is one of the tools that can be used to acquire capital for a number of purposes. Essentially asset-based financing leverages the value of assets such as buildings, real estate, inventory or accounts receivable as collateral for a loan. The practice of using asset based financing has increased as small businesses or cash strapped organizations recognize that there is value in using this type of loan to obtain working capital. Typically a bank or commercial lending institution will make a line of credit available based on formulas that are unique to each lender. Real estate may qualify for up to 80% of its net value whereas inventory or accounts receivable may only qualify for 35-50% of their value. The interest rate charged for loans of this type also varies among lending institutions, but is typically higher than rates charged for ordinary commercial loans.
This type of borrowing should be carefully analyzed to determine if the risk is commensurate with the potential reward as the cost of the capital is high. However, opportunities for growth can be realized if this method of financing is determined to be practical and feasible. The assumption in this discussion is that ordinary commercial loans are not available and the owners, stockholders or managers of an organization recognize the value of an investment opportunity is worthy of the risk. This type of financing is especially suitable for acquisitions that present themselves and offer an above average opportunity to increase market share, consolidate or diversify holdings or grow the company. Asset based financing can also be used for buy-out purposes by employees or to raise working capital. Employees or managers that desire to acquire their company can use the assets of the company for collateral to complete the transaction or a company can raise working capital necessary to continue operations if there is considerable equity in buildings or real estate holdings. There are a number of other reasons that asset-based financing may be applicable that center on bankruptcy, reorganizing, restructuring or recapitalization programs that offer an opportunity for a company confronting difficulties to use the value of assets to inject new life or new opportunities into the organization.
Obviously, this type of lending presents risks that are higher that those associated with conventional commercial loans so one can expect that the lender will want to closely monitor the activities of the borrower to insure that the terms and conditions of the loan are followed. A borrower can anticipate that a number of reports, records and audits will be required as part of the conditions of the loan transaction. This type of monitoring will add to the cost of the loan.
The bottom line of using asset-based financing is that it provides a creative way to leverage the assets of an organization, which may lead to financial success. Concomitantly, one must recognize that the road to success is littered with the corpses of those that failed to adequately anticipate the ruts and potholes that that must be negotiated to reach their destination. For the bold entrepreneur, asset-based financing presents a unique opportunity to secure business opportunities and success.
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