What is an Asset Based Loan (ABL)?
If you’ve caught yourself wondering “what is asset based lending?”, you aren’t alone. An asset based loan (ABL), also known as asset-based financing, uses a business’s assets, such as its accounts receivables, to secure a revolving line of credit to cover expenses or investments.
Historically, cash flow revolved around the invoicing process, and the lag between money coming in after goods or services are delivered creates a bottleneck. Cash can be eaten up covering the costs of day-to-day operations and payroll, leaving little behind for more strategic business endeavors. ABLs are commonly used to help launch or expand lines of business, or help fund other expansions.
ABL is a tempting alternative to traditional loans for many organizations, and is currently a popular short-term fix as a disrupted economy looks to get back on track. But while this established practice can seem enticing on its face as a way to free up capital and scale quickly, it’s important to take a closer look at the role it plays in B2B business. Like many alternative funding methods, ABL carries a unique set of risks and requirements that are not a match for every situation.
A beginner’s guide to ABL
On the whole, banks lent nearly half a trillion dollars to businesses in 2018 using ABL, with projections showing that number will only grow in future years. Common use cases for Asset Based Loans include:
- Startups that are rapidly scaling: ABL can help a startup meet a big surge in demand before the first invoices start coming in.
- Small to mid-sized businesses (SMBs) that need extended runway: SMBs sometimes need a few months worth of cash to pay for a variety of business needs, like extra seasonal workers or normal fluctuations in business.
- An organization that faces unexpected business challenges: COVID-19 is a recent example of an external event that can cause businesses to seek new sources of funding.
The Asset Based Loan process
The specific process and complexities of asset-based lending will vary heavily depending on the bank, but generally, the process has several common steps.
- A business approaches a bank with documentation proving their current A/R book or record of all receivable assets.
- The bank reviews all receivable assets and vets them — accounts with late payments, extended terms and other deficiencies are weeded out. The bank then determines a “base” value of the assets, and sets a percent that can be borrowed.
- The business chooses whether or not to accept the terms of the loan. If it accepts, the entire accounts receivable book becomes part of that loan — even cash from accounts excluded from the loan cannot be used in other financing arrangements.
- When invoices are paid, the business pays back the bank. The process of collecting information on each account is done on a regular basis.
Asset Based Loans in practice
ABL and asset lending often plays an important role in keeping many businesses running. But this longstanding source of capital has limitations, and advances in fintech have made alternatives to ABL more attractive. In the next posts of this three part series on ABL, we’ll explore the complexities of ABL in practice, including the significant risks the borrower accepts and the resource-heavy task of keeping the bank abreast of business. Additionally, we will discuss technology that helps business owners get paid quicker, while still offering the terms-based payments their customers are used to.