Which is better for you: Asset-Based Lending or Invoice Factoring?
Why an asset-based loan may be the better solution for your business
Now, more than ever, there are numerous ways of financing a small business. For companies that do not qualify for a traditional bank loan, they have the option of choosing between alternative small business lenders. In industries that are invoice heavy, the two most popular options are asset-based lending (ABL) and factoring.
Both of these forms of lending heavily rely on the assets of the borrower but are structured in different ways in terms of costs, borrowing amounts and how they operate. In asset-based lending, the invoices will typically serve as collateral for a line of credit, while in factoring, the borrower will sell the invoice to a factor in exchange for a cash advance.
In the end, asset-based lending is a superior option for companies that have a variety of asset types and are looking for a cheaper and more flexible solution than traditional factoring.
3 ways in which asset-based lending is better than traditional invoice factoring:
- Structure and costs
- Bigger borrowing base
- Structure and Cost
One of the crucial differences between the two types of financing is the structure in which the borrower takes out and pays back their loan. In factoring, the borrower will sell individual invoices to the lender for an advanced amount of cash, which can be as high as 85% of the total invoice value. Then as the customer pays back the invoice, the lender will collect the advance amount, take a fee, and then return the remainder to the borrower.
On the other hand, asset-based lenders will look at a pool of accounts receivables and other assets such as inventory, machinery and real estate, to determine a total borrowing base that will be split between lines of credit and sometimes term loans. These assets will serve as collateral to the debt facility, but not be sold to the lender.
How the costs may look for either option
- Over the course of 12 months, a borrower sells $500k worth of invoices each month to a factoring company at an 80% advance rate with a 2.5% fee.
- At the end of the year, the total cost of the monthly factoring is $150k for $400k in financing. This calculates to an APR of 37.5%.
- For an asset-based lender that structures the facility as a line of credit. The borrower will pull $400k from their line at a fixed 18% annual interest rate for a total cost of $76k after one year.
The other benefit for the line of credit is that if the business does not need the capital at the moment, the owner will not be charged an interest rate until they need the cash. Being charged only when money is withdrawn means that the line of credit is more flexible than the invoice sale in factoring.
Another important aspect for both types of financing is how they interact with the company’s customers who have the outstanding invoices, which is called “notification”. Factoring is a notification type of financing. Customers that have their invoices sold to a lender will receive notice that a third party is now handling the invoice and that they will receive the repayment. This can be seen as a negative to a lot of businesses who do not want their customers worrying about the implications of their invoice being sold.
This is different from asset-based lenders who are non-notification. When creating the debt facility, the lender will also create a lockbox. This account will receive all invoice payments, pay down the line of credit debt, and then distribute the remainder back to the borrower. This does require the business to notify their customers that their invoices have been sold to a third party.
- Bigger Borrower Base
The final major advantage of asset-based lending vs. invoice factoring is that in ABL, the borrower will typically have access to more capital to borrow. While factoring is solely based on the invoices being sold, ABL looks at a variety of assets to serve as collateral in order to build a total facility. Since this facility is built on the different types of collateral being provided, it will be larger than just the accounts receivable portion that would be the sole focus on factoring companies.
While both financing options are available to similar types of clients, asset-based lending provides the most flexibility and cost-effective way of providing capital to businesses that are cash-strapped and could use a helping hand.