Asset-based financing is the strategy of securing the financing for major purchases by pledging some type of asset as collateral for the loan. This approach often involves the use of real estate or equipment as the pledged asset, although some lenders will consider just about any asset that has some type of verifiable market value. Using an asset-based financing method is often desirable, since the rate of interest that is payable to the lender is usually less than on financing deals that are considered unsecured.
A good example of asset-based financing would be the purchase of new equipment for a manufacturing facility. In order to obtain an equitable rate of interest, the business may choose to pledge the facility itself as the collateral for the loan used to acquire the equipment. The lender, who is assuming less risk since a valuable asset has been pledged as collateral, is willing to provide that lower rate of interest. Until the loan is repaid in full, the business cannot sell the facility without the express permission of the lender. In the event that the debtor does default on the loan, the lender has the right to assume full ownership of the pledged collateral, a move that allows them to fully recoup the investment in the original loan.
Businesses may utilize other holdings as part of the asset-based financing approach. It may be possible to use the inventory of finished goods as the collateral for the loan. One common strategy today is to make use of the current accounts receivable as a means of obtaining an advance on those receivables that is repaid incrementally as customers remit payments on those outstanding invoices. With the use of receivables as the collateral for an advance loan, a process that is known as factoring, the lender advances a certain percentage of the total amount of receivables for a specific billing period. The lender then receives the payments on invoices directly from the customers of the debtor, and keeps a small percentage of those receipts as the fee for providing the advance.
Asset-based financing also takes place with individuals. For instance, a homeowner may choose to take out a loan in order to make some improvements to the property, and use an asset that is fully owned by the homeowner, but is not pledged as collateral on any other type of loan. That asset may be jewelry, art, real estate that is currently not mortgaged, or even stocks or bonds. Until the loan is repaid in full, the owner is not free to dispose of those assets without the permission of the lender.
