SME SHort Notes on 'Asset based financing'

A specialized method of providing structured working capital and term loans that are secured by accounts receivable, inventory, machinery, equipment and/or real estate. This type of funding is great for startup companies, refinancing existing loans, financing growth, mergers and acquisitions, and management buy-outs (MBOs) and buy-ins (MBIs).  An example of asset-based finance would be purchase order financing; this may be attractive to a company that has stretched its credit limits with vendors and has reached its lending capacity at the bank. 

The inability to finance raw materials to fill all orders would leave a company operating under capacity. The asset-based lender finances the purchase of the raw material, and the purchase orders are then assigned to the lender. After the orders are filled, payment is made to the lender, and the lender then deducts its cost and fees and remits the balance to the company. The disadvantage of this type of financing, however, is the high interest typically charged - which can be as high as prime plus 10%. In the simplest meaning, asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a mortgage is an example of an asset-backed loan. More commonly however, the phrase is used to describe lending to business and large corporations using assets not normally used in other loans. 

Typically, these loans are tied to inventory, accounts receivable, machinery and equipment. This type of lending is usually done when the normal routes of raising funds, such as the capital markets (selling bonds to investors) or normal unsecured or mortgage secured bank lending is not possible. This is usually because the company was unable to raise capital in the normal marketplace or needs more immediate capital for project financing needs (such as inventory purchases, mergers, acquisitions and debt purchasing). It is usually accompanied by higher interest rates, and can be very lucrative for the parent company. For example, the bank Wells Fargo made more money from asset-based lending business than it did the rest of its corporate business (both lending and fee based services). Many financial services companies now use asset-based lending package of structured and leveraged financial services. Most banks, both national investment banks (Goldman Sachs, RBC) and conglomerates (i.e. Citigroup, Wells Fargo), along with regional banks, offer these services to corporate clients.