how asset based lending works
many businesses need to take out loans or obtain lines of credit to meet routine cash flow demands for example a business might obtain a line of credit to make sure it can cover its payroll expenses even if there s a brief delay in payments it expects to receive if the company seeking the loan cannot show enough cash flow or cash assets to cover a loan the lender may offer to approve the loan with its physical assets as collateral for example a new restaurant might be able to obtain a loan only by using its equipment as collateral lenders might require a negative pledge clause or covenant as part of the loan this clause will limit the borrower from reusing the pledged asset for another loan the terms and conditions of an asset based loan depend on the type and value of the assets offered as security lenders prefer highly liquid collateral such as securities that can readily be converted to cash if the borrower defaults on the payments loans using physical assets are considered riskier so the maximum loan will be considerably less than the book value of the assets interest rates charged vary widely depending on the applicant s credit history cash flow and length of time doing business interest rates on asset based lending are lower than rates on unsecured loans since the lender can recoup most or all of its losses in the event that the borrower defaults examplefor example say a company seeks a 200 000 loan to expand its operations if the company pledges the highly liquid marketable securities on its balance sheet as collateral the lender may grant a loan equalling 85 of the face value of the securities if the firm s securities are valued at 200 000 the lender will be willing to loan 170 000 if the company chooses to pledge less liquid assets such as real estate or equipment it may only be offered 50 of its required financing or 100 000 in both cases the discount represents the costs of converting the collateral to cash and its potential loss in market value special considerationssmall and mid sized companies that are stable and that have physical assets of value are the most common asset based borrowers however even large corporations may occasionally seek asset based loans to cover short term needs the cost and long lead time of issuing additional shares or bonds in the capital markets may be too high the cash demand may be extremely time sensitive such as in the case of a major acquisition or an unexpected equipment purchase 