Dec 11, 2023

The Founder’s Guide to Acquiring Asset Financing in 2024

Arc Team

Go-To-Market

Asset financing - the basics

What asset financing is (and isn’t)

Asset financing allows startups to acquire assets, such as machinery, equipment, vehicles, or technology, without paying the full purchase price upfront. Instead of using working capital or cash reserves, companies can secure financing arrangements to spread the cost of acquiring assets over time. In asset financing, the acquired asset typically serves as collateral for the financing arrangement. The lender provides funds to the startup, allowing it to acquire the asset immediately, while the business agrees to repay the borrowed amount over a specified period.

How asset financing works

Asset financing is an umbrella term that describes a few forms of financing, each of which can be used to obtain an asset. That said, the process of asset financing is fairly straightforward.

Initially, startups identify their specific asset needs based on operational requirements. This could range from machinery and equipment to vehicles or intangible assets like software and intellectual property. Once the assets are identified, startups select one of the asset financing options based on their unique circumstances, which can be structured as an operating lease, a financing lease, or a straight-up asset-backed loan.

After acquiring the asset, repayments on the loan balance begin. These can be structured as either fixed monthly payments that cover the principal and the interest or a bullet loan with an interest-only period followed by a balloon payment at the end of the term.

Depending on the financing option selected, at the end of the loan term, the startup may have the option to purchase the asset outright for its residual value.

The common types of asset financing

As mentioned above, there are three common structures of this form of financing: operating leases, financing leases, and asset-backed loans.

Operating Lease: Startups essentially rent the asset for a predetermined period, with the option to return, or extend the lease at the end of the term. For more information, check out the founder’s guide to operating leases.
Finance Lease: Also referred to as a “capital lease” this is similar to an operating lease, except that at the end of the lease term, the startup can choose to purchase the asset at its residual value, and the lessor transfers ownership to the lessee. For more information, check out the founder’s guide to financing leases.
Asset-Based Loan: This is a straight-up loan that is used to purchase an asset upfront. The startup must make a down payment and a series of monthly payments until the balance is paid off. For more information, check out the founder’s guide to asset-backed loans.

The kinds of assets, asset financing can be used for

There are two types of assets that this form of financing can be used for, tangible and intangible. Tangible assets are physical, while intangible assets are not. Outlined below are some examples of tangible and intangible assets.

Tangible Assets

Machinery and Equipment: Asset financing is frequently utilized for the acquisition of machinery and equipment essential for manufacturing, production, or service delivery.
Vehicles: Companies often opt for asset financing to acquire vehicles, whether for a fleet of delivery trucks, corporate cars, or specialized vehicles.
Real Estate: In some cases, businesses use asset financing for real estate, particularly when acquiring commercial properties or expanding their facilities.

Intangible Assets

Intellectual Property: This form of financing extends to intangible assets like patents, trademarks, and copyrights.
Software: With the increasing reliance on technology, this form of financing is commonly applied to acquire software licenses or develop customized software solutions.
Branding and Trademarks: Companies may use asset financing to invest in building a brand or acquiring trademarks.

The common terms found in an asset financing agreement

When entering into an asset financing agreement, startups encounter various terms and conditions that define the structure and obligations of the arrangement. Outlined below are the key terms often found in this form of financing agreements:

Interest Rate: The rate applied to the financing amount.
Repayment Period: Duration for repayment of the financing.
Collateral: Assets used to secure the financing.
Default Conditions: Circumstances leading to a default on the financing agreement.
Early Repayment Terms: Provisions for settling the financing before the agreed-upon term.
Residual Value: Also known as, economic life, this is the estimated value of the asset at the end of the financing term.

Understanding whether asset financing is right for your use case

Asset financing offers startups a strategic avenue for acquiring essential assets for use in their day-to-day operations. The advantages and disadvantages outlined below are intentionally broad, given asset financing is an umbrella term used to describe multiple forms of financing.

The advantages of asset financing

Preserves Working Capital: Rather than making a large capital outlay upfront to purchase an asset outright, with an operating lease or financing lease the startup can make fixed monthly payments.
Easier to Qualify: Given that this form of financing is collateralized, lenders are more willing to extend credit to startups that do not have a robust credit profile.
Tax Benefits: This may or may not apply depending on your location and the structure of your deal. In some cases, startups can write off the interest expense and depreciation.

The disadvantages of asset financing

Restrictive: As the name implies, asset financing only applies to the lease or purchase of an asset. It can not be used for working capital, hiring, or acquisitions.
Higher Total Cost: Over the financing period, the total cost of leasing the asset (via an operating or financing lease) can be higher than an upfront purchase.
Default Risk: Failure to meet repayment obligations may result in default, leading to the repossession of the financed asset.

The eligibility criteria for asset financing

There are several factors that lenders will consider when determining whether or not your startup is qualified for some form of asset financing. Outlined below are some of the most common factors that go into this decision.

Creditworthiness: Lenders typically evaluate the creditworthiness of startups applying for asset financing. They are often required to provide recent financial statements, including income statements, and balance sheets.
Financial Stability: Lenders assess the financial stability of the startup, considering factors such as profitability, cash flow, and existing debt obligations.
Information about the Asset: Details about the asset being financed, including its value, specifications, and relevance to the business's operations, are typically required.
Asset Appraisal Results: Lenders may conduct independent appraisals or assessments to ascertain the fair market value of the asset.

The process to become approved for asset financing

Initial Inquiry and Consultation: Startups initiate discussions with potential lenders or financial institutions and try to understand the lender's requirements and expectations.
Submission of Application: Applications typically include the required documentation and details about the intended asset acquisition.
Credit and Financial Review: Lenders conduct a thorough review of the startup’s creditworthiness and financial stability.
Asset Evaluation and Approval: Simultaneously, the asset undergoes evaluation, including appraisals and assessments.
Documentation and Agreement: Startups and lenders finalize the agreement, clarifying repayment terms, interest rates, and other pertinent details, and sign on the dotted line.

Frequently asked questions (FAQs) about asset financing

How does Asset Financing differ from traditional loans?

Unlike traditional loans that rely heavily on creditworthiness, asset financing is specifically tied to the value of the asset being financed. The asset itself serves as collateral, making it a viable option for early-stage startups with minimal credit history.

What types of assets can be financed?

A wide range of assets can be financed through asset financing, including tangible assets like machinery, vehicles, and real estate, as well as intangible assets like intellectual property, software, and trademarks.

How does the evaluation of the asset take place?

The evaluation of the asset involves assessing its value, condition, and relevance to the business's operations. Lenders may conduct independent appraisals or assessments to determine the fair market value of the asset.

What happens in case of default?

In the event of default, where a startup fails to meet its repayment obligations, the lender may have the right to repossess the financed asset.

Can assets be used as collateral in other financing arrangements?

Yes, assets that have been financed can potentially be used as collateral in other financing arrangements, depending on the terms of the existing financing agreement.

Is it possible to finance used assets?

Yes, many asset financing arrangements accommodate the financing of used assets. Lenders may consider factors such as the age, condition, and residual value of the used asset when determining the terms of the financing.

Can startups or businesses with limited credit history access asset financing?

While startups with limited credit history may face challenges, some lenders offer asset financing solutions specifically designed for such situations.

Are there restrictions on how the financed assets can be used?

The use of financed assets is often outlined in the financing agreement. While some agreements allow flexibility in the use of the asset, others may have restrictions.

Can assets financed through leasing be upgraded or replaced before the end of the term?

Yes, leasing agreements often provide businesses with options to upgrade or replace assets before the end of the lease term (often with a fee of course).

Wrap up - acquiring asset financing in 2024

Asset financing can be a great option for startups looking to purchase tangible or intangible assets. Depending on the startup’s situation, an operating or financing lease may make more sense if they do not want to make a large outlay upfront. This preservation of capital, along with the fixed repayment terms make operating or financing leases attractive, however, because they ultimately cost more than an outright purchase (e.g. an asset-backed loan) they may not be right for every startup. If you’re looking for asset financing, we’d love to help—get in touch with us.