Last month, we discussed using equity to finance a business.  For our last installment of the series, I will discuss using the assets of a business to finance the business.

Assets

            Asset Based Financing (ABF) is the practice of using existing assets in a business to help finance that business.  The website Allbusiness.com explains ABF as, “A way for rapidly growing, cash-strapped companies to meet their short-term cash needs.  In general, companies can tap their assets to generate cash flow through asset-based loans or through factoring.”  So, what is an asset?

            For our context, an asset can be defined as anything owned by a business that has a value. In accounting terms, an asset is something of future economic benefit obtained as a result of previous transactions.  Examples of business assets include cash, land, buildings, equipment, inventory, intellectual property, and accounts receivable.

Asset Based Lending

            How can a business use these assets to finance the business?  Through banks and alternative financing companies, a business can often times obtain cash by using the assets as collateral.  A company can refinance real estate to obtain cash for the business.  Some lenders will consider certain inventory as collateral and loan up to 50% of the inventory value.  Additionally, there are multitudes of leasing companies that will assist with financing new or used equipment.  The largest issue with all of these forms of financing is that they create debt, which means they are for a large part dependent on the business owner’s credit worthiness.

Factoring

Another type of ABF is accounts receivable financing or factoring.  When a company provides goods or services to a customer, and allows that customer to pay 10, 30 or 60 days later, they create an asset called an account receivable (“AR”).  Factoring allows a company to sell their AR in exchange for cash today, allowing the growing company to pay employees and expenses on time and continue to grow.  In a typical factoring transaction, a company may receive 80-90% of an invoice immediately, with the remainder funded upon receipt of the payment (minus the factor’s fee). 

General ABF Advantages and Disadvantages

            Generally speaking, small companies can receive more cash more quickly through ABF.  Furthermore, due to the collateral value, ABF providers place a smaller emphasis on the borrowers credit score.  Most factors will even provide financing to companies even if there has been a recent bankruptcy or current tax liens.

            The largest drawback to ABF is the cost, which is almost always higher than traditional loans.  However, for companies that cannot borrow traditionally, or can generate increased business due to the ability to create cash as needed, ABF is a valuable part of the small business financing mix.

If you have any comments on this discussion or have a suggestion for future discussions, please don’t hesitate to email me at terracinaj@ifgtx.com.