This lesson will compare and contrast the basics of invoice factoring versus asset-based lending. Asset-based lending (aka asset-based financing) is one of those lesser-known commercial financing options. It is in the same broad family as invoice factoring but differs significantly and is most commonly used in certain types of situations.
What are Invoice Factoring and Asset-Based Lending?
- Invoice factoring is when a business sells its most current invoices to an invoice factoring company and then collects on them within 2-3 days (or less). The debtor, or the business’s client, remits payment directly to the factoring company within the usual 30-day window.
- Asset-Based Lending is when a company uses its existing assets (not necessarily invoices) as collateral to secure a loan or a line of credit. Asset-based financing is more commonly used in manufacturing and wholesale sectors. Sometimes inventory, manufacturing equipment, machinery, and even the facility itself can be used as collateral.
Asset-Based Financing is Similar to a Business Loan
Let’s review the similarities and differences of these financing options:
- Asset-based lending is similar to a typical business loan in that collateral – equipment, assets, or even receivables – is used as an indemnity to get the loan or line of credit. When most people hear the word collateral, they think loan and that’s generally true.
- It is also similar to a business loan in that if you don’t pay back the money that was issued to you as set out in the contractual agreement, the financing institution will exercise its rights to seize your assets.
Yet asset-based loans are more similar to factoring in the manner in which they are used. They are typically used during a business crunch time or when an unexpected opportunity occurs that requires quick action. A seasonal manufacturer, for instance, may obtain asset-based financing using its actual factory equipment as collateral in order to ramp up holiday production to meet an increase in demand. It is in this way – expediency — that asset-based lending is more similar to invoice factoring. Factoring services are all about speed and getting a line of credit fast. A typical bank may take months to process a business loan whereas the application process for asset-based lending loans is much simpler. If your business needs cash or a line of credit yesterday, you probably can’t wait for a loan. Asset-based lines of credit are issued quickly and for that reason (and others) they are lumped in with invoice factoring services.
Level of Risk is Another Reason the Two Are Linked
Asset-based financing is often paired with invoice factoring because the two options are considered higher risk financial endeavors than standard small business loans. For financial companies, high risk can be determined by a number of factors, including: lack of business establishment, poor credit history, low credit score, business loss or lack of profitability, too much debt, and more. In these situations, when the lending institution is taking on a higher risk, there is a greater cost to you the applicant. Whenever you need cash in a hurry, it will cost you more (think of the post office). For this reason, you can expect AR financing to cost more. And, since asset-based lending is typically done on an as-needed basis you may pay more for it than you do for invoice factoring services. If you are factoring receivables on a month-to-month basis for a 12-month period with the same client, you will pay less (provided that the client always pays on time).
Asset-Based Lending No Longer Considered Low-Brow Financing Options
It may be worth mentioning here that this financing method was once viewed with skepticism in the industry as it was often used as a last-chance effort to save a faltering company. In addition, while invoice factoring is often used with current invoices, asset-based lending is sometimes used when a company doesn’t have solid current receivables to secure a line of credit. Much skepticism associated with these financing options has gone away in recent years as more and more companies see the benefits. Moreover, with banks refusing more loans, businesses have recognized them to be viable funding options.
Answering the Following Questions May Help You Decide Which Option Is Best for Your Business:
- Does your business need a line of credit right away to pay for a one-time seasonal business expense? Is your business in manufacturing, reselling, or wholesaling? If so, then asset-based financing might be your best choice.
- Does your business operations struggle month-to-month due to on-going cash flow troubles? If so invoice factoring may be the better financing option.
- Does your business need a line of credit but lacks a viable client with current receivables even though it has considerable physical assets to offer as collateral? Then asset-based lending may be for you.
- Has your business been established five or more years? Does it have a profitable record of growth and a solid credit score with little to no existing debt? Can your business wait several weeks or longer to obtain needed capital or credit for business growth or expansion? If so, then you may consider applying for a business loan.