Asset Based Lending vs. Cash Flow Lending

Start ups, small businesses and small cap to large cap corporations can take out a wide range or loans such as structured business loans, commercial loans, commercial hard money loans, bridge loans, mezzanine financing, lines of credits, equipment loans. mergers and acquisitions capital. However all these loans types will fit into one of two categories or a mix of the two – Asset Based or Cash Flow.

Lending based on cash flow enables companies or individuals to borrow cash, dependent on the company’s past and forecast of profit and loss cash flows. In contrast, asset-based loans enable companies to borrow capital, dependent on the value of assets. Here’s an overview of asset-based and cash flow lending, and the benefits and drawbacks of each approach:

Lending Based on Cash Flow

With these types of loans, financial institutions provide loans that are guaranteed by the borrower’s business or personal cash flows. Essentially, this means that companies borrow cash from profits that they think they will make in future. To qualify for these loans, credit scores and historic cash flow records are important.

For instance, companies that are trying to fulfill their payroll duties may use cash flow funds to pay their staff now, then repay the loans and relevant interest on the money generated by their staff at a later date. Loans like these do not need any kind of physical collateral, such as assets or property. Rather, lenders will evaluate predicted company income in future, their credit scores and their value as enterprises.

This approach is beneficial in the sense that companies can acquire financing quickly because collateral appraisals are not necessary.

Loans based on cash flow are underwritten by institutions who calculate credit capacity. To do this, they normally use EBITDA (which is what the company earns prior to taxes, interest, amortization, and depreciation) as well as a credit multiplier.

This method of financing allows lenders to take into account risks related to industry and economic cycles. When a recession hits, many companies experience a reduction in their EBITDA, and the bank’s risk multiplier will reduce too. The net result of these two occurrences is that an organization’s available credit resources will decline.

Cash flow lending is more suitable for companies that have balance sheets with high margins, or that have insufficient assets to use as collateral.

Examples of companies that satisfy this criterion are advertising firms, companies that manufacture low margin products and service companies. Typically, rates of interest for cash flow loans are more than other loans, because lenders can’t obtain any physical collateral if borrowers default on payments.

Lending Based on Assets

This type of lending involves business loans that are guaranteed by the value of a company’s assets. Borrowers receive this money by using accounts receivable, inventory and/or additional balance sheet assets for collateral. Although cash flows (especially those connected to a physical asset) are taken into account when offering these loans, they are not the main factor considered.

Assets that are often used as collateral for capital loans include real estate, other physical properties and land, manufacturing equipment and company inventory, or physical commodities. In contrast, security backed lending uses bonds or stocks as collateral. Should the borrower fail to pay back the loan or default, the lender can take the collateral and sell it to recover the loan.

Asset loans are most suitable for companies that have assets to securitize a loan. Companies that need capital to function and expand, especially in sectors like renewable energy, which may not offer much potential for cash flow. These loans can give companies the funds to tackle their lack of growth and facilitate revitalization.

Based on a firm’s credit score, they may be able to access anything financing on receivables, business equipment, real estate, manufacturing tools,  physical inventory, etc as possible collateral.

There are stringent rules with asset-based loans, with regards to the status of physical assets used for obtaining loans. Most importantly, no individual or company can use these assets as collateral to obtain other loans. If these assets are presented to other lenders, former loan providers have to subordinate their positions to acquire the assets. The first lender can even accelerate a loan due if another lien is placed on the same collateral.

Lastly, the company receiving the loan has to tackle all legal, tax or accounting problems before an agreement. These issues might prevent lenders from securing and selling assets in liquidation.

Regardless of the type of loan you are looking to obtain whether asset based or cash flow based, we have the solution for your capital needs. We will evaluate your position and create the right debt structure for your organization.

We Offer all types of startup, small business, small cap, mid cap and large cap corporate financing solutions. We look forward to providing you the capital you need to be successful and focus on your business.