Security backed lending gives you access to capital to buy real estate, purchase a personal property, expand a business, or invest in a company. As its name implies, this type of loan is secured by eligible assets or collateral.
What are the Eligible Assets?
Depending on the nature of your business, security backed lending might be secured by your inventory, equipment and other similar valuable properties, accounts receivable, or balance-sheet assets.
Most asset-based lenders give more importance on your accounts receivable, due to its high liquidity, than other securities like inventory and real estate.
Your eligible assets, particularly relating to its liquidity, will have a large impact on the credit limit and the lending rate. For instance, having high monthly accounts receivable could allow you to take bigger business loans while having high-liquid assets or collateral often results in more favorable (lower) lending rate.
What are High-Liquid Assets?
Generally speaking, assets that are considered liquid can be converted into cash in a short period of time, with no or very little loss in their value. Traditionally, accounts receivable and cash equivalents such as stocks, US Treasuries and bonds, money-market funds, and mutual funds are considered highly liquid assets.
Meanwhile, less liquid assets usually include real estate and inventory (e.g., food items, electronics, and clothing), which are not easily converted into cash.
How Much Is Your Credit Limit?
Again, the portion of business loans that are security-backed will depend on the value and the liquidity of your collateral.
Your credit limit may be as high as 70-90 percent of the value of your monthly accounts receivable, or around 65 percent of your eligible inventory.
Situations That Make Security Backed Lending Favorable
If your business operates in the retail industry, chances are you have come to realize the importance of working capital to purchase large inventory ahead of the holiday season. The same is true for original equipment manufacturers (OEMs) that produce parts and equipment that are sold by another manufacturer.
Security backed lending may also suit distributors and suppliers who often deal with fluctuating commodity cost.
For the most part, security backed lending may suit borrowers with no cash flow, those who are too indebted but have some “free” assets that can be used as new collateral, and those with a poor credit rating.
In general, the access to security backed lending is easier if you have a good amount of accounts receivable–and the customers who receive your goods and/or services are generally good payer.
Nonetheless, this type of loan also lends against other types of securities such as capital equipment, real estate, and inventory, although the largest portion of the collateral would still be your receivables.
Security Backed Lending vs. Traditional Loans Arrangement
Traditional banks and lenders generally focus more on your business model and cash flow, whereas security backed lenders are more focused on the value of your collateral and your input costs, the liquidity of your eligible assets, and your customers’ financial viability.
And since security backed lenders rely heavily on the value of your asset, they generally have somewhat lenient financial covenants. In fact, they often lack financial maintenance tests in their loan agreements.
Banks and traditional lenders, meanwhile, almost always require financial maintenance tests. Their goal is to obligate you, the borrower, to meet certain performance standards, such as debt service, on a monthly or quarterly basis.
Simply put, banks expect to be repaid from your cash flow. They generally do not want to be repaid with assets such as real estate, which would be their last resort should their borrowers default on their payment.
Sometimes, security backed lending will even allow you to undertake certain actions that are generally restricted by most traditional loan agreements. This added flexibility is arguably one of the most appealing features of this type of business loan.
Another Bonus of Security Backed Lending: Revolving Line of Credit
This type of loan usually takes the form of a revolving line of credit, meaning it is refreshed when you are able to pay down the collateral. Hence, it appeals to businesses that require large inventory ahead of a holiday or “busy” season, and distributors and suppliers who are exposed to fluctuating commodity cost.
What Are Your Ideal Business Loans Facilities?
The ideal business loan facility–security backed loan vs. traditional lending option–will depend on the economic climate, your company’s need and core operations, and the interest rate. A good rule of thumb is to choose business loans with low-interest rate and favorable legal terms.
We service different types of loans from residential hard money to commercial hard money. Our products are designed for all businesses, including mergers & acquisitions. We don’t provide denials, only approvals. Call today for a consultation.