Summary: Factoring and asset-based loans are types of asset-based financing. Factoring finances Accounts Receivable only and is intended for smaller companies. On the other hand, asset-based loans enable you to finance several types of assets and are better suited for larger companies.
While these products have some similarities, they are very different. This article provides an overview of each product, their similarities, and their differences. It will help you determine which one is best suited for your company. We cover the following subjects:
- What is an asset-based loan?
- What is invoice factoring?
- Similarities
- Differences
- What solution is best for your company?
1. What is an asset-based loan?
An asset-based loan (ABL) is a solution that allows companies to leverage their assets. It allows companies to finance Accounts Receivable (A/R), inventory, equipment, machinery, and corporate real estate.
Asset-based loans structure their lines to match the type of asset they are financing. Lines secured by A/R or inventory typically offer a revolving facility. All other assets are financed using a term loan. Lines with mixed collateral typically have a revolving facility and a term loan. Read “What is an asset-based loan? How do they work?” to learn more.
a) Who uses asset-based loans?
Asset-based loans are typically used by small- to middle-market companies that invoice a minimum of $1 million per month. Many companies prefer an ABL because compliance is easier than with a bank loan.
These lines are simpler to obtain than bank financing and can often be set up faster. They are available to companies that are growing quickly. However, they may also be used by distressed companies or companies assigned to special assets.
b) Advantages
Asset-based loans have a number of benefits over conventional bank facilities. Their main advantages include simpler qualification requirements, flexible covenants, and adaptive credit limits. Usually, your credit limit will grow as your revenues from eligible clients grow.
2. What is factoring?
Invoice factoring is a type of asset-based financing where a factoring company finances your Accounts Receivable. The line behaves similarly to a revolving line, advancing between 80% – 90% of your open invoices.
While they are often compared with asset-based loans, factoring lines only finance invoices. They don’t finance other assets. Consequently, you can only compare factoring against an ABL that finances A/R only.
Factoring transactions are typically structured as the purchase of your A/R rather than as a loan. Consequently, lines have simple qualification requirements and can usually be deployed quickly. Read “How does factoring work?” to learn more.
a) Who uses invoice factoring?
Invoice factoring is typically used by small and middle-market companies that need to improve their liquidity. Their main challenge is that they offer terms to clients but need funds sooner to improve cash flow and cover operating expenses.
Factoring lines have simple qualification criteria. However, they have tighter controls and asset-based loans. These lines are typically used by companies that cannot qualify for an ABL.
b) What are its advantages?
Invoice factoring can be a great alternative for companies of all sizes that cannot obtain conventional funding. The lines are also available to distressed companies.
These lines typically have flexible covenants that simplify compliance and management. They also have simple qualification criteria and can be deployed quickly.
3. Similarities between factoring and asset-based lending
Factoring lines are asset-based loans are not as similar as many business owners think. They only have three important similarities.
a) Revolving line
Both factoring lines and asset-based loans provide a revolving line of financing secured by A/R. The line is adaptive and grows as the company’s revenues grow.
Note: ABLs only provide a revolving facility when secure by A/R or inventory.
b) Simpler qualification
Both solutions have simpler qualification requirements and compliance than bank financing. This makes both solutions an attractive alternative when compared to conventional financing.
c) Collateral based
Both are asset-based financing solutions that require you to have existing assets as collateral. Additionally, your A/R must be from companies with good business credit.
4. Differences between factoring and asset-based loans
Factoring and asset-based loans have several differences. The following six are the most important.
a) Collateral and structure
Both lines differ in the collateral they require and the structure they use. Factoring lines can only finance invoices using a revolving line. They are typically secured by the purchase of A/R.
Asset-based loans can finance invoices, inventory, machinery, equipment, and corporate real estate. Depending on the collateral, lines can be structured as revolving lines or term loans.
b) Size
Factoring lines are available to businesses of all sizes, including very small businesses. On the other hand, asset-based loans typically require a minimum line of $1,000,000. They are designed to support lower midmarket companies.
c) Risk level
Factoring is provided to new and growing companies that can’t qualify for conventional bank financing. On the other hand, asset-based loans are offered to more established companies with larger collateral bases. Larger companies typically have better financial controls and are considered a lower risk.
d) Cost
Asset-based loans are cheaper than invoice factoring lines and are priced differently. Factoring lines are priced by discounting the full value of the invoice by a percentage. The typical rate goes from 1.15% to 3.5% per 30 days.
On the other hand, asset-based loans are priced using an annual percentage rate (APR). The APR typically uses a “prime + X%” structure, where “prime” represents the prime rate.
e) Controls and compliance
Factoring lines have simple compliance requirements and few covenants. However, factoring companies monitor collateral carefully to ensure accuracy.
Asset-based lines have more covenants than comparable factoring lines. However, lenders typically rely on clients to generate the borrowing certificates to draw funds. Note that lenders monitor and appraise collateral regularly.
f) Due diligence
Most factoring facilities require little due diligence, and lines can be deployed quickly. Usually, the factoring company reviews the client’s financials and reviews collateral to ensure the quality of the A/R. This review can be done in a day or two and is inexpensive.
Asset-based loans require substantially more due diligence and often charge a due diligence fee. This is due to their size, structure, complexity, and the collateral they support.
Lenders typically review financial statements and tax returns, which must be accurate. They also appraise all physical collateral, which may require a site visit to your facilities.
5. Which product is best for your company?
Companies that invoice less than $700,000 per month should consider factoring since they may be too small for an ABL. Additionally, companies that cannot provide reliable financial statements or tax returns are unlikely to qualify for an ABL.
Companies that invoice over $700,000 and can provide reliable financial reports should consider an asset-based loan. An ABL can work even in turnaround situations, provided the company has a realistic path to profitability. Factoring should be considered as a backup option if the ABL process does not work out.
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