Lenders charge interest rates and usually require some kind of collateral, i.e., valuable assets which they can take over and sell if the loan is not repaid on time. The exceptions are called “unsecured loans,” those requiring no collateral. They usually involve smaller amounts and higher interest rates due to high risk to the lender, because he has no recourse if the borrower does not pay it back as agreed.
Two forms of unsecured loans are credit card debt and peer-to-peer lending. The other source for an unsecured loan might be friends and family.
Banks, being risk-averse, have fairly strict rules on the types of collateral they will accept: real estate, machinery in place or other “hard” assets, and cash accounts. But there are alternatives to banks – lenders who have a more flexible view of acceptable collateral.
This is called asset-based lending or ABL. Unlike a bank loan, ABL loans may be secured by business assets whose value changes over time. Examples include a machine that is being purchased, a major purchase order, raw materials inventory, work in progress inventory, finished goods (as yet unsold) inventory, and accounts receivable. The purpose of such loans is to provide the working capital to enable the business to bridge the time lag between spending on production and receipt of payment.
The amount of asset-based loans “can be up to 85% of accounts receivable and up to 60% of inventory.” The form of such loans can be an ordinary term loan, or a revolving line of credit which is paid off and renewed as the secured collateral evolves. ABL interest rates are higher than bank loans, but less than credit card debt. The time required for approval of ABL loans can be quite short. Their purpose can include refinancing as well as ordinary business operations.
“Factoring” is another form of ABL, usually applied to accounts receivable. This involves actually selling the asset – the accounts receivable – for less than face value to a lender, who then collects from those customers over time. It can be especially attractive “when domestic banks will not lend [on foreign receivables] due to credit risk, country risk, and exchange rate risk” (Goldblatt). The downside of factoring, aside from a discount or interest rate, is reputation risk. Customers may lose confidence in the firm and refuse to place additional orders due to concern for its financial stability.
Another asset ignored by banks but considered by alternative ABL lenders is intellectual property or IP: patents, trademarks, or copyrights. An intellectual property loan can generate cash without actually selling either the IP itself or a stake in the business. Aside from the interest rate, the issue with IP loans is how to value the intellectual property, which is why it is not feasible for startups. In fact, most ABL is not available to startups, with the exception of purchase order financing.
ABL involves higher interest rates due to greater risk, but there are plenty of companies in the business. For example, Fisher Enterprises is a New York-based clearinghouse representing several hundred non-traditional money sources, generally non-bank lenders for amounts from $50,000 to $500M. Fisher charges a retainer for their efforts, which is credited against a 1 to 3% success fee at closing.
While bank loans remain the lowest cost form of debt financing, alternative financing in the form of asset-based loans is available to going concerns who need a capital infusion to finance growth and operations, and who are willing to pay for it.