If your small business is looking for alternate financing from a private lender there are many options available. In fact, there are so many options it can be difficult to separate the good from the bad. Two of the lowest cost options are asset-based lending and factoring. To learn more about how these two are similar, different, and which option might be right for you, read on.
How Asset-Based Lending Works
Asset-based lending is a traditional loan but is based on the assets your business currently holds. You can use your equipment and inventory as collateral against the loan but most lenders prefer to use your open accounts receivable. Because other parts of your assets involve selling the collateral to collect a bad debt, you won’t get as much funding if you use them as collateral.
When you use your accounts receivable, the lender will look at who owes you money. If they have good credit and are likely to pay your invoice, you’re more likely to secure an ABL loan. You’ll repay the loan over the next several months to a year, at interest that varies from 7% to 15%, depending on prime. You’ll never borrow more than you have coming in and your customers will never know that you took on the loan.
How Factoring Works
Factoring is another lending method that relies on your accounts receivable. It is not a traditional loan, because there is nothing to pay back. Instead, you sell your open invoices to a factoring company for a percentage of their face value. Even more than asset-based lending, your business credit isn’t nearly as important as your customers’ credit. Because of this difference, applying for factoring is very fast. You can go from needing cash to having cash in under a week. If your business is in a crunch, factoring is the way to go. You do pay for this convenience through higher fees than an ABL loan.
By selling your invoices, your customers will be notified that you’ve entered a factoring agreement. With a notice of assignment, they’ll be notified to send their payment directly to the factor. At the same time, you won’t be responsible for collecting from slow-paying customers and can offer better terms to your customers.
Both styles of lending are based on your accounts receivable but asset-based lending maintains your privacy and has lower associated fees. Factoring is faster but isn’t private and costs more. Your choice should be based on your relationship with your customers and your business’s financial needs.