Asset-Based Lending: A Modern Overview

Sterling Commercial Credit Asset Based Lending
January 2015

Asset-based lending comprises of many different kind of loans that can be granted to a borrower wherein some kind of assets serve as the security. Factoring & asset based lines of credit are the two common type of asset-based loans which are practiced.

In case of factoring, a factor or a financial institution comes into play which buys the outstanding accounts receivable of the business. Thus, factoring is not a typical kind of loan as it involves sale of receivable and a direct third party involvement in the business. The lending amount that is generally granted by the factor ranges between 70 to 90 percent of the value of the account receivable when this purchase is made.

A factoring fee is taken from the remaining amount and the balance is released when the invoices are collected. Factoring fee can be anywhere between 1.5 to 3 percent, based on risk profile. This fee depends on factors like the risk involved and the number of days for which the funds issued will be used.

A factoring agreement gives freedom to the business to choose which invoices it wants to sell to the factor. Once an invoice is sold, the factor manages the receivable and related collection. The factor becomes a de facto credit manager for the business and performs credit checks, manages payments and other related tasks. The documentation of these payments and analyses of credit reports also becomes the responsibility of the factor.

A Line of Credit loan is more of a typical bank loan with certain notable differences. A traditional loan can be secured through collaterals like equipment, personal assets or real estate, but A/R lending is restricted to securing the loan through trade outstanding account receivable. Under the account receivable lending arrangement, each draw by the borrower results in generation of a borrowing base against which the business is allowed to borrow. The lending institution charges a collateral management fee against the outstanding amount. If the funds are advanced, the borrower is charged interest only on the amount which has been actually borrowed.

An invoice can contribute towards a borrowing base only it is less than 90 days old. There are other eligibility conditions to A/R financing that can be exercised by the lender. These include cross-aged, government customers, international customers and concentration limits on a particular customer. Sometimes, if a particular customer has a higher share in the collateral, the lender can choose to do a background check on that customer to decide the credit worthiness of the business.