These loans require a physical asset to be used as collateral, which the lender would take possession of and resell should the entrepreneur default on the loan. Such assets can include equipment, inventory, product, receivables or real estate.
Depending on the nature of the business, it can be difficult to obtain an asset-based loan because lenders don’t generally like to liquidate items for which there may not be a consistent market demand.
The Canada Small Business Financing Program recently made efforts to increase the availability of loans and capital leases through a federal program to encourage financial institutions and leasing companies to serve the small business sector.
Some important points about the pros, cons and general accessibility of asset-based loans:
Limits the losses — It can be beneficial to obtain a loan that is secured by specific physical assets because the lender would only be entitled to take possession of those particular items should the business incur financial difficulties. This means the lender assumes the risk for the loan and if it falls in arrears, the borrower can simply remove the asset and debt from company’s balance sheet.
Popular applications — The most common reason for seeking an asset-based loan traditionally has been to expand an existing business. Most borrowers are medium- sized companies with money tied up in assets, but which require a cash infusion for growth or to cover expenses during a slump. Lenders have preferred to deal in amounts of $1-million or more, although access to asset-based loans for small business is increasing.
Typical qualifications — Although lenders are more receptive to asset-based loan applications by small enterprise owners, the borrowing business must generally be established to qualify. Fixed assets are most often used to secure an asset-based loan, although receivables, inventory and product can be used. However, the business must have solid financial statements, good reporting systems and be free of liens.
Cost of borrowing — Asset-based loans often will cost more than traditional loans because, other than the asset being used as security, the lender does not have access to any additional collateral. Rare or unusual physical assets that might not be easily liquidated can increase the cost of borrowing. To quantify their risk, lenders generally categorize asset-based loans as low, medium or high, which will also determine the cost.
Lease financing — Industry Canada launched the Capital Leasing Pilot Project in 2002 to improve access to lease financing for small and medium-sized businesses. Lease financing is a type of asset-based loan that is provided by financial institutions and leasing companies. This means of financing is beneficial because a lease is not a traditional debt and doesn’t appear on theÂ balance sheet as a company liability.
For businesses starting out, it is possible to get an asset-based loan to purchase equipment although lenders will usually require a down payment of at least 20%. Eligibility and repayment terms for startups to access such loans depend on the longevity of the asset, which can range from five to 10 years for equipment. Borrowing to pay for leased equipment could become a more readily accessible option for new enterprises as lease financing for small business increases.