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What CPA to know about using asset-based lending and factoring as alternatives to traditional bank financing
Once considered financing of last reson, asset-based lending and factoring have become popular choices for companies that do not have the credit rating or track record to qualify for more traditional types of financing.
In general terms, asset-based lending is any kind of borrowing secured by an asset of the company. This article will consider asset-based lending to mean loans to businesses that are secured by trade accounts receivable or inventory.
Asset-based lenders focus on the quality of collateral rather than on credit ratings. Borrowers pledge receivables, inventory and equipment as collateral. Traditional bank lenders may have significant problems with asset-based loans. Banks are constrained by both internal credit granting philosophies as well as federal regulations. Banks typically do not accept transactions with debt-to-worth ratios higher than four or five to one. Asset-based lenders that are either nonbanks or separate subsidiaries of banks are not subject to such constraints. This gives asset-based lenders the freedom to finance thinly capitalized compames.
REVOLVING LINES OF CREDIT (REVOLVERS)
A revolver is a line of credit established by the lender for a maximum amount. Revolvers are used by retailers, wholesalers, distributors and manufacturers. The line of credit typically is secured by the company's receivables and inventory. It is designed to maximize the availability of working capital from the company's current asset base. A typical term for a revolver is one to tirree years or longer. The borrower grants a security interest in its receivables and inventory to the lender as collateral to secure the loan. In most cases, lenders require personal guarantees from the company's owners.
The security interest creates a borrowing base for the loan. As receivables are collected, the money is used to pay down the loan balance. When the borrower needs additional financing, another advance is requested.
The borrowing base consists of the assets that are available to collateralize a revolver. It generally consists of eligible receivables (defined below) and eligible inventory The size of the borrowing base varies with changes in the amounts of the borrower's current assets limited to the overall revolving line of credit. As the borrower manufactures or acquires new inventory, and as it generates...