Asset-Based Lending and Factoring are two different types of receivables financing. The obvious similarity between asset-based lending and factoring is that both provide benefits to businesses by providing capital prior to collection. Both options help businesses gain instant access to working capital, and cost very little compared to the costs associated with cash flow problems. However, asset based financing can often be confused with other products, so it’s important to understand the distinctions.
With that said, asset-based lending (ABL) and factoring have a clear distinction. In ABL, the invoice is used as loan collateral, and the business retains ownership of the invoice. An asset based loan is a type of financing secured by a company’s assets, which can include accounts receivable, inventory, and equipment. In invoice factoring a business sells its book of accounts receivable to a third party called a factor. In return, the factoring company will provide the business with a cash advance at a predetermined rate. Asset-based lending allows companies to secure loans using their company’s assets as collateral, highlighting that the amount borrowed is influenced by the value of these assets.
Here are some additional differences that a business should evaluate when considering which method of alternative financing is right for them:
Underwriting — A key difference between asset based lending and factoring lies in the underwriting process. While factoring companies will typically provide more flexibility with underwriting criteria in deal structures, ABL terms will usually be more stringent. Asset based lending institutions will be more diligent and base their funding decision on a good balance sheet and proof of profitability of the company receiving the loan. This is due to the fact that the borrower maintains responsibility for collection on the invoices being used as collateral. Underwriting for factoring on the other hand is largely dependent on the creditworthiness of borrower’s customers.
Control — In ABL, the business receiving that financing is still responsible for collecting the invoice from the customer, while still being able to access funds in advance. In factoring, the financing company becomes responsible for collecting the invoice from the customer. Some businesses may prefer this, as they can focus on their core operations rather than collecting the invoices. However, a business may not prefer this if they would like to maintain control over their credit and collections process.
Rate — Costs for factoring are typically lower than asset based lending. However, this completely depends on the specific terms of the financing agreement. Factoring companies may add additional fees such as account setup charges and annual maintenance fees which can make it more expensive, however, the overall rate is largely dependent on the creditworthiness of the customers and their likelihood to pay. In asset based lending, the rates are more dependent on the quality of the assets and the terms of the loan. These financing options can help address financial challenges faced by businesses, such as cash-flow issues and capital requirements for expansion. Compared to traditional bank financing, these options are often more accessible for small or start-up companies, while larger, established firms may find asset-based loans more suitable.
Understanding Asset-Based Lending and Factoring
Asset-based lending and factoring are two popular financing options for businesses that need to manage their cash flow and working capital. While they share some similarities, they have distinct differences in terms of their structure, benefits, and requirements.
Asset-based lending is a type of financing that allows businesses to use their assets, such as accounts receivable, inventory, and equipment, as collateral to secure a loan or line of credit. This type of financing is often used by businesses that have a strong balance sheet and a proven track record of profitability. Asset-based lenders typically provide a loan-to-value ratio of 75% to 90% for accounts receivable and 50% or less for other collateral.
Factoring, on the other hand, is a type of financing that involves selling a business’s accounts receivable to a factoring company at a discounted rate. The factoring company then collects payment from the customer and pays the business the remaining balance, minus a factoring fee. Factoring is often used by businesses that have cash flow problems or need to finance their growth.
Both asset-based lending and factoring can provide businesses with the working capital they need to operate and grow. However, the choice between the two depends on the specific needs and circumstances of the business.
Key Differences Between Factoring and Asset-Based Lending
While both factoring and asset-based lending provide financing options for businesses, there are key differences between the two. Here are some of the main differences:
- Structure: Asset-based lending is a loan or line of credit secured by a business’s assets, while factoring is the sale of a business’s accounts receivable to a factoring company.
- Collateral: Asset-based lending requires a business to pledge its assets as collateral, while factoring requires a business to sell its accounts receivable.
- Risk: Asset-based lending carries more risk for the lender, as the business is responsible for repaying the loan. Factoring, on the other hand, carries more risk for the factoring company, as it is responsible for collecting payment from the customer.
- Cost: Factoring fees are typically higher than asset-based lending interest rates, but factoring companies often provide more flexible terms and faster funding.
- Requirements: Asset-based lending typically requires a business to have a strong balance sheet and a proven track record of profitability, while factoring requires a business to have creditworthy customers.
- Flexibility: Factoring provides more flexibility than asset-based lending, as businesses can sell their accounts receivable on a selective basis. Asset-based lending, on the other hand, typically requires a business to pledge all of its assets as collateral.
- Speed: Factoring provides faster funding than asset-based lending, as factoring companies can provide funding within 24 to 48 hours. Asset-based lending, on the other hand, can take several days or weeks to fund.
In summary, asset-based lending and factoring are two different financing options that cater to different business needs. While asset-based lending provides a loan or line of credit secured by a business’s assets, factoring involves selling a business’s accounts receivable to a factoring company. Understanding the key differences between these two options can help businesses make informed decisions about their financing needs.
Recourse vs. Non-recourse factoring: Collections and Factoring Companies
In a non-recourse arrangement, the financer takes on most of the risk if the company’s customers fail to pay their invoices. If the arrangement is on a recourse basis, the company will remain responsible for any issues with non-payment. Asset based loans can also be structured on a recourse or non-recourse basis, depending on the lender’s requirements.
While there is no clear distinction, factoring is more likely to be conducted on a recourse basis, whereas asset-based lending could be conducted both ways. When ABL is conducted on a recourse basis, the lender may request additional assets from the company if the loan amount goes beyond the value of the collateral provided. This setup does not exist when a loan is conducted on a non-recourse basis.
Which method of receivable financing is best for your business?
As described above, both asset-based lending and factoring can be extremely beneficial to companies looking to unlock working capital. Factoring is a financial transaction where a company sells its accounts receivable for immediate payment. Given that there are some clear similarities and differences between the two, our team has put together a questionnaire that will determine which receivables financing method is right for your situation:
— Does your company have outstanding accounts receivables?
— Does your company need access to funding in less than 30 days?
— Are you willing to give up control of some of your company’s assets in order to receive funding?
— Are you comfortable with losing your accounts receivable a company cannot pay back the funding?
— Are you comfortable with the idea of having a lien placed on your company’s assets?
— Does your company have a history of timely payments to creditors?
— Is maintaining a good credit score important to your company?
— Does your company anticipate needing funding for greater than 6 months?
— Does your company still want to take responsibility for credit and collections?
Depending on your selections to these questions, your business may be a great fit for either asset based lending or factoring. Make sure to fill out our contact form and our team would be happy to assist you in making the right selection.