Small Business Financing 101: Asset-Backed Financing

Katie Fleming

Katie Fleming

Co-founder and COO of Owner Actions

Multiple excavators in a row are an example of the assets a business can borrow against.

There are many ways to finance a business. One that few business owners consider is asset-backed financing, an option that allows you to leverage the assets your small business owns.

Lots of banks and credit unions offer asset-backed loans to people willing to leverage their business’s assets to fund their startup. Often, owners will finance their inventory, machinery, non-mortgaged real estate, or another tangible asset with verifiable value to access this fast form of funding.

 

Why would I choose this approach over another form of financing?

You might consider an asset-backed loan in any of these circumstances:

  • You'll need additional capital beyond what you can attain from other financing sources.
  • You don’t qualify for a traditional term loan.
  • You don’t want to put up any personal assets as collateral for financing.
  • Your business has assets that could be leveraged to achieve your funding goals.

 

Asset-backed loans often have less stringent requirements than traditional term loans. Lenders may consider your financial history and personal creditworthiness. However, but they’re far more interested in the value of your business assets, which they can use as collateral if you default on the loan.

 

How does this kind of loan work?

Lenders will determine how much money you can borrow by examining the value of your assets. In most cases, they allow owners to borrow up to 85% of the value of their accounts receivable and up to 50% of the value of their inventory or equipment.

Depending on your preference, the lender can offer you a revolving line of credit or structure a loan for an amount that’s equal to those percentages.

 

Could I lose the assets that I put up for collateral?

Yes. If you default on your loan, the lender will be entitled to seize those assets, liquidate them into cash, and use the proceeds to cover their losses.

Collateral provides a safety net for lenders, so banks often consider them to be lower-risk investments. Because of this, many are more willing to provide this loan than their term loan offerings.

 

How do I apply for an asset-backed loan?

To start, you’ll need to contact commercial banks, community banks, and credit unions in your area to determine who offers this form of financing. Ask each institution about their payment plans and terms and the speed of their approval process. This step will help you determine which lenders can meet your needs.

Next, you’ll gather the documents your preferred lender needs to process your application. These documents will likely include:

  • The business’s balance sheets for the past two years, plus a year-to-date balance sheet
  • The business’s profit-and-loss statements for the last two years and a year-to-date profit-and-loss statement
  • Sales projections for the next three to five years
  • Business and/or personal tax returns for the past three years
  • Business and/or personal banking statements for the past 12 months
If your business is less than three years old, you should speak with your banker about other documents you can provide to demonstrate the financial strength of your business.

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Then, you’ll need to create a list of your assets and their respective values. If you plan to leverage the business’s inventory, you’ll need to provide an inventory statement with a count of the items you plan to include and each item’s approximate (or appraised) value. If you plan to leverage equipment or machinery, you'll need documentation of each item’s age, condition, and resale value.

You may need to work with a third-party valuation specialist to find the market value of your equipment, machinery, and inventory. Be sure to ask your lender about this requirement.

If you’d like to connect with an experienced valuation specialist, click the button below to get started:

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Next, you'll submit these documents and a completed loan application to the lender. The lender will ensure that there are no outstanding liens on your assets by performing a Uniform Commercial Code search. They may also have your financials audited by a third-party firm while they review the other elements of your application.

After an initial review, most lenders will ask for a preliminary commitment to move forward with the loan process. They may present you with a non-binding offer with the loan amount, interest rate, and terms they believe they can provide. To move forward with the process, you'll be asked to sign a term sheet and, in some instances, pay a due diligence fee for the bank to conduct the rest of its investigation. The remaining steps of the process will include a complete audit of the documents you provided and an in-person assessment of the materials that will serve as collateral for the loan.

If you’re approved for the loan, you’ll be presented with closing documents. Within days of signing and submitting these documents, you should receive the financing you requested.

Important note: Lenders who offer asset-backed loans may perform periodic checks on your assets to verify their value. These checks can occur at any time throughout the tenure of your loan.

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Not sure if this form of financing is right for you? Learn about SBA loans, term loans401(k) options, portfolio loans, and other options, including angel investors and venture capital, in our article, Your Go-to Guide to Raising Capital for Your Small Business.

 

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