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.
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. 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.
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.
Recourse vs. Non-recourse factoring: Collections
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.
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 receivables finance 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. 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.
