Asset-based lending, also known as asset-backed lending or asset-based finance, is the practice of issuing a loan to a company for an agreed-upon amount that is backed by a certain asset, known as collateral. The size of the loan is based on the value of the assets being used as collateral. In the event that the borrower is unable to repay a loan with interest, the lender obtains ownership rights to the asset. Interest rates tied to an asset-based loan tend to be higher than for more traditional loans. In some cases, asset-based loans may be accessed as a last resort by a company that is unable to obtain more traditional financing.
Various types of assets are may be used as collateral in a loan structure. For instance, a company may use its accounts receivables, business inventory, or real estate to secure a loan. Proceeds from the loan might cover operational expenses or fund a financial restructuring or a merger. The borrower retains the rights of ownership to its assets unless it fails to make promised payments.
Loans tied to asset-based lending may be distributed in different forms. A bank may choose to extend a line of credit to a borrower, which means that a company can draw on funds up to a certain amount as needed. The benefit to a line of credit is that the interest payments are typically only charged for the funds accessed from the revolving loan, which means the borrower only pays interest on what it uses.
Asset-based lending is a common source of funding for companies with compromised credit or too much debt already on a balance sheet that prevents them from obtaining cheaper loans from a financial institution. It is also common among start-up companies with little financial history in need of steady cash flow. Asset-based lending might be chosen over equity finance because the latter requires that a company cede some of its ownership over to shareholders.
Hedge funds use asset-backed lending as a common trading strategy. An asset-based lending hedge strategy, for instance, might involve a company that is pursuing a particular project, such as an oil and gas drilling endeavor. If the company is unable to obtain financing from an investment bank, it might turn to a large hedge fund for capital using the project as collateral. In the event the company becomes unable to repay the loans, the hedge fund takes ownership of the said project. The new owners can continue to operate the project or attempt to sell it to another company for a profit.
