In the first segment of this series, Small Asset-Based Lenders Find Their Niche, I explained that there is a new breed of asset-based lenders that will handle smaller companies. In order to find the best one for your business there are a number of considerations you should be aware of.
The cost of using a small asset-based lenders
When you decide to use a small asset-based lender you have to consider the end to end cost of fees and interest. Don’t assume that a small asset-based lender that quotes a low interest rate will be the least expensive as measured in dollars. Here are a few types of expenses and fees that small asset-based lenders may charge that other types of commercial finance companies may not charge your company.
Most business owners think that asset-based loans are cheaper than invoice factoring. That isn’t always the case.
Assume that you will have $500,000 of funds employed through your asset-based lender. These estimates are average across a number of small asset-based loans:
- Due diligence fees: $5,000 to $11,000 before your asset-based loan is approved
- Origination fees: Typically an asset-based loan will have an annual fee for maintaining the line of credit. It will approximately be 1% of the commitment amount of the line of credit
- Legal fees to draw up loan documents: Some small asset-based lenders include this in the origination fee while others don’t. If they don’t esimtate $500 to $2,500 for loan documents
- Monitoring fees: Some asset-based lenders want to conduct onsite examinations from one to four times a year. If your business is simple this will take two days per examination. Estimate $750 to $1,000 a day
- Non-usage fee: Most asset-based loans come with a provision that requires you to pay a minimum monthly fee if your borrowing doesn’t meet the agreed upon threshold. Some charge a flat fee, some a percentage of the average amount that was not used for the month
- Interest rates: Large asset-based lenders charge an interest rate in the low teens. Smaller asset-based loans may carry an interest rate in the high teens or even low 20% APR range
What kind of assets do you need to finance?
Small asset-based lenders want to finance current assets such as accounts receivable, finished goods inventory, and raw materials. Occasionally a small asset-based lender will agree to put equipment into the borrowing base. This is helpful when starting a relationship with the lender and when the borrower needs to leverage the fixed assets in order to restructure debt. Often though, using multiple types of financing is a better option.
For accounts receivable a small asset-based lender will advance an average of 75% to 80% of the amount of accounts receivable. With inventory there are more variables and ways to estimate the advance rate. In general a good rule of thumb is an advance rate of 50% of liquidation value. In the case of a recent transaction involving wine, the small asset-based lender I was working with was willing to advance 35% of the cost of raw materials necessary to manufacture the alcoholic beverage.
If any inventory cannot be liquidated because it was made with registered trademarks of others or for a particular client under contract the inventory is probably cannot be financed. A few years ago a small Austin Texas based business asked me to help them find financing for their company that made laptop carry cases for Dell Computers. The Dell logo was on various places on the laptop back and the buttons were all stamped with Dell’s logo. No asset-based lender would finance that kind of inventory because of there would be no market to sell the carry cases if the lender had to liquidate them.
The best inventory assets are simple commodity type items that have a high liquidation value. Material used in the oilfield, metals used in fabrication or machining, raw ore, and other items that won’t become obsolete are better for asset-based loans than electronics and highly perishable items. There are a few small asset-based lenders that do like to finance frozen fish, fresh produce, and other types of inventory that turnover fast.
Small asset-based lenders – how much is negotiable?
It is important to note that not all small asset-based lenders charge all of the fees listed in the above paragraph. Those that do will often “start high” and expect you to negotiate some of the fees down as you work through the process. The process is a bit like buying any large piece of equipment for your business.