Dec 6, 2023

The Startup Founder's Guide to Asset-Backed Loans in 2024

Arc Team

Go-To-Market

Startup founders often seek flexible financing options to fuel their growth. For those with significant assets, such as hardware startups, D2C startups with large amounts of inventory, biotech companies with machinery and equipment, or real estate startups with physical properties, asset-backed loans (ABL) may be a viable solution. In this guide, we break down ABL, and share all of the key factors to consider when deciding whether to pursue this funding option! Let’s dive in!

Asset-backed lending - the basics

What asset-backed loans are (and aren’t)

Asset-backed loans, also referred to as “asset-based loans”, and “ABL” are any kind of loan or line of credit that is secured by an asset. If the loan is not repaid, the pledged asset is taken by the lender. The assets listed serve as security for the loan, mitigating the risk for lenders and providing a viable funding source for startups.

This collateralized approach allows businesses to unlock the intrinsic value within their operations. The term “asset-backed loan” is an umbrella term that can include: secured loans, equipment financing, accounts receivable financing, real estate loans, inventory financing, and several others. Asset-backed loans are typically not dilutive, restrictive, or slow to fund.

How asset-backed loans work

Asset-backed loans are a dynamic financial arrangement that operates on the principle of leveraging a company's assets to secure a loan. The process involves assessing the startup’s assets, determining the terms of the deal, and managing the underlying collateral. We’ve broken down each of these steps in more detail in the following section.

Initial Assessment

During this phase, asset-backed lenders meticulously evaluate the value and liquidity of the non-physical and physical assets that the startup intends to pledge as collateral. This assessment delves into the market conditions, industry trends, and the financial health of the company. Asset-backed lenders consider the type of assets, their current market value, and the potential for fluctuation in value over time.

Market Valuation: Lenders may employ appraisers or valuation experts to determine the fair market value of the assets.
Asset Liquidity: The ease with which assets can be converted into cash is a critical factor. Highly liquid assets are generally more favorable.

Loan Amount and Terms

Once the initial assessment is complete, lenders proceed to determine the loan amount and terms based on the assessed value of the assets. The loan-to-value ratio (LTV) is a key metric used in this phase. LTV is a percentage that represents the ratio of the loan amount to the appraised value of the collateral.

Loan-to-Value Ratio (LTV): This ratio helps lenders decide how much of the asset's value can be used as collateral. The higher the LTV, the riskier and more expensive the loan.
Interest Rates and Terms: The interest rates and terms of the loan are then established, taking into account the assessed risk, market conditions, and the financial health of the borrowing company.

Collateral Management

Post-approval and loan funding, lenders implement monitoring systems to ensure compliance with the agreed-upon loan terms and to mitigate any potential risks.

Audits: Lenders may conduct periodic audits of the assets to verify their existence, condition, and market value. This ensures that the collateral remains consistent with the initial assessment.
Reporting Requirements: Businesses are often required to provide regular financial reports and updates to the lender.

Common terms you may come across when applying for an asset-backed loan

Outlined below are some of the most common terms you may encounter when applying for an asset-backed loan, if you have additional questions, consider seeking legal counsel.

Loan-to-Value Ratio (LTV): The ratio of the loan amount to the appraised value of the pledged collateral. Lenders use this metric to determine the risk and collateral coverage of the loan.
Advance Rate: The percentage of the appraised value of collateral that lenders are willing to advance as a loan.
Personal Guarantees: A commitment by the startup founder to personally repay the loan if the business is unable to meet its obligations.
Covenant: The agreed-upon conditions or restrictions that the borrower must adhere to throughout the loan term.
Inventory Audits: Periodic assessments and verification of the quantity and value of the business's inventory.
Cross-collateralization: The use of multiple assets as collateral for a single loan, which can expand the pool of assets securing the loan, providing additional security for the lender.
Maturity Date: The date on which the loan must be repaid in full.
Interest Rate: The fee assessed for borrowing the funds.

Assessing whether an asset-backed loan is right for your startup

Advantages of Asset-Backed Loans for Startups

The advantages of ABL extend beyond traditional financing methods, providing startups with tailored benefits that align with their unique needs and challenges.

Improved Liquidity

Unlocked Asset Value: One of the primary advantages of ABL is its immediate impact on a startup's liquidity. By using assets on the startup's balance sheet like accounts receivable, inventory, or equipment as collateral, ABL allows businesses to unlock the inherent value of these assets. This, in turn, injects much-needed liquidity into the company, providing a vital financial cushion for day-to-day operations, and expansion initiatives.
Enhanced Working Capital: The improved liquidity resulting from ABL empowers startups to effectively manage working capital. Access to readily available funds ensures smoother operations, timely payments to suppliers, and the ability to capitalize on market trends, ultimately contributing to the sustainability and growth of the business.

Flexibility in Funding

Diverse Asset Utilization: Unlike traditional financing methods that may have stringent criteria, ABL stands out for its flexibility. Startups can leverage a variety of assets such as accounts receivable, inventory, machinery, or real estate to unlock capital.
Customized Borrowing Limits: ABL doesn't adhere to a one-size-fits-all approach. Instead, it offers a borrowing structure that is tailored to the startup's asset portfolio.

Low Cost of Capital

Favorable Borrowing Costs: Due to its securitized nature, ABLs often come with more favorable interest rates compared to alternative financing options.
Minimal Dilution: Most ABL loans do not come with a dilutive or convertible component, such as warrants.

Disadvantages of Asset-Backed Loans for Startups

While Asset-Backed Lending (ABL) offers financial flexibility and liquidity, startups should be cognizant of the potential drawbacks that come with this financing method.

High Collateral Requirements: One of the notable drawbacks of ABL is the potential requirement for startups to pledge substantial collateral. Lenders may insist on a significant portion of the company's assets to secure the loan, which can limit the startup's ability to qualify for future financing.
Rigorous Oversight: Asset-backed loans involve a heightened level of scrutiny and oversight compared to some other financing options. Lenders often implement stringent monitoring and reporting requirements, necessitating regular updates on financial performance, asset valuations, and compliance with loan covenants.
Administrative Burden: The rigorous reporting obligations can impose an administrative burden on startups, requiring them to allocate resources to meet documentation and reporting deadlines which can divert attention away from core business activities.
Challenging For Asset-Light Startups: Companies with few tangible assets, commonly referred to as asset-light startups, may encounter challenges in accessing asset-backed loans since ABL relies on the presence of tangible collateral.

Tips for success and FAQs on asset-backed loans

Tips for success when pulling funding from an asset-backed loan

Navigating the intricacies of an asset-backed loan(ABL) requires a strategic approach and proactive engagement. Here are some tips to ensure your startup is set up for success when considering ABL as a financing solution.

Conduct Regular Assessments: Conduct frequent evaluations of the assets being used as collateral. Regular appraisals and valuations can help optimize the asset portfolio, potentially increasing borrowing capacity and demonstrating diligence to lenders.
Active Risk Mitigation: Proactively identify potential risks associated with the pledged assets. Develop and implement risk mitigation strategies to address fluctuations in asset value, industry challenges, or economic changes that may impact the collateral's worth.
Maintain Communication with Lenders: Establish and maintain open lines of communication with lenders. Regularly update them on the company's financial performance, operational successes, and challenges.
Implement a Robust Financial Monitoring System: Continuously track and analyze your startup’s financial metrics, to ensure that you remain in compliance with loan covenants.
Develop Contingency Plan: Develop contingency plans for various scenarios, including economic downturns or fluctuations in asset values.

Frequently asked questions about asset-backed loans

What types of assets can be used as collateral for an asset-backed loan?

A variety of assets can serve as collateral for an asset-backed loan, including accounts receivable, inventory, machinery, equipment, and real estate. The specific types of assets accepted depend on the lender's criteria and the nature of your business.

How does the loan-to-value ratio (LTV) impact the amount I can borrow in an asset-backed loan?

The loan-to-value ratio (LTV) is a crucial factor that determines the proportion of the asset's appraised value that can be borrowed. A higher LTV allows you to access more funds, but it also increases the risk and may affect interest rates and terms.

What are the typical interest rates for an asset-backed loan?

Interest rates for asset-backed loans vary but are generally more favorable compared to unsecured loans. In 2023, we saw loans that ranged from Prime +2% to Prime +10%.

How long does it usually take to get an asset-backed loan?

The timeline for obtaining an asset-backed loan varies but can range from a few weeks to a couple of months. The process involves a thorough assessment of assets, financial due diligence, and legal documentation.

Are personal guarantees required for asset-backed loans, and what does that entail?

Personal guarantees are often required, implying that the startup founders commit to repaying the loan personally if the business cannot.

Are there restrictions on how I can use the funds from an asset-backed loan?

In most cases, there are no stringent restrictions on fund usage, providing flexibility for working capital, expansion, or other business needs.

What happens if the value of my assets changes during the loan term?

Changes in asset value are common, and lenders may conduct periodic assessments. If there are significant fluctuations, it could impact your borrowing capacity.

Can I repay an asset-backed loan early, and are there prepayment penalties?

Early repayment is often possible, and it can be advantageous. Some loans may have prepayment penalties or fees, so it's essential to review the terms of the agreement.

What is the typical maturity date for asset-backed loans, and how is it determined?

The maturity date varies but is often tied to the useful life of the assets used as collateral. It's determined through negotiations with the lender and should align with your business's long-term financial plans.

Wrap Up - Asset-Backed Loans in 2024

Asset-backed loans (ABL) offer a unique structure to startups. The ability to unlock liquidity from your assets, along with their flexible nature and favorable interest rates make ABL an attractive option for high-growth startups. However, ABLs require substantial collateral, and rigorous monitoring, and come with a risk of default, so they’re not right for every startup. If you’re interested in getting approved for an asset-backed loan, get in touch with us.