Sometimes factoring and asset-based lending are confused as being the same thing when really, they are two very different forms of financing. While factoring is asset-based, it is structured differently from asset-based lending, providing different risks, costs and benefits to the customer. What follows is an explanation of factoring and asset-based lending, including what makes these two financing models different from each other.
How Factoring Works
Factoring is a financial transaction in which a company sells its accounts receivable to a third-party factoring company in exchange for faster payment. The company benefits because it receives 90% or more of an invoice value within a day instead of waiting two to three months on a customer payment. The factoring provider then collects payment on the invoice from the customer and pays the balance to the company, minus a factoring fee.
How Asset-Based Lending Works
Asset-based lending is a loan or a revolving line of credit that is secured using a company’s assets as collateral. Like factoring, asset-based lending can use receivables as collateral, but it can also extend to other assets like equipment, real estate, inventory and raw materials.
The amount of money a company can borrow through asset-based lending depends on the value of the assets that are put up as collateral. Asset-based loans provide a loan-to-value ratio (LTV), which can be between 75% and 90% for receivables, but often 50% or less on other collateral. If the value of your company’s assets changes, it will affect how much money you can borrow through an asset-based loan.
Factoring vs. Asset-Based Lending
The Similarities
Factoring and asset-based lending are similar in that they both serve as viable alternatives to traditional lending for businesses looking to boost cash flow. Other similarities include:
- Quick access to cash: Both options provide you with fast access to cash, rather than waiting weeks or months to access funds tied up in assets or receivables.
- Qualifying is often simple: When compared to taking out a traditional loan with a bank, it’s much easier for most companies to meet the qualifications and compliance requirements for asset-based lending or factoring services.
- Credit history is taken into consideration: Though the qualifications aren’t as strict as bank financing, the factoring company or asset-based lending services you use will consider your credit history and risk.
- Available for any industry: Asset-based lending and factoring can both be utilized across multiple industries, including trucking, manufacturing, oilfield services and more.
The Differences
- Factoring is faster: The approval process for factoring generally involves reviewing the credit ratings of your company and your customers, which only takes a few days. To qualify for an asset-based loan, however, the value of the assets that will be used as collateral needs to be verified. This can take the lender several days or weeks.
- Asset-based lending is more private: Before you enter into a factoring agreement, the factor must contact your customers to verify their accounts with your company. The factoring company will remain in contact with your customers since it handles invoice collections. That means your clients will learn that you are using factoring as a way to fund your business. Alternatively, asset-based lending is more private, as there is little interaction between the lender and your customers—unless you are using accounts receivable as collateral.
- Factoring takes on more risk: Factoring providers are generally more likely to extend funding to small or start-up companies that often do not qualify for traditional bank financing. Asset-based loans, however, are designed for larger, more established companies that have significant assets and are well on their way to becoming “bankable.”
- Factoring can be more flexible: Factoring is a sales transaction, not a loan. There are no required monthly payments to a lender. Factoring invoices takes place with each sales transaction, which means that funding from factoring can “scale up” with your company’s growth as your receivables increase.
- Different Cost Structure: Factoring fees are determined as a percentage of an invoice value, usually between 1.5% and 3.5% for each receivable. Asset-based loans are priced with an annual percentage rate (APR), often ranging between 7% and 15%.
Which Solution is Right for You?
When deciding between factoring and asset-based lending, it’s important to consider the current state of your business and your future goals. Factoring tends to be better for small- to mid-sized businesses with a steady flow of invoices. Factoring allows these companies to immediately receive payment on open invoices and access working capital to perform their day-to-day operations. Additionally, as these companies look to grow, factoring can provide flexible cash flow to help support future expansion.
On the other hand, asset-based lending could be better for larger and more established companies. Because these companies tend to have stronger assets, it may be easier and more cost-effective for them to obtain a loan even with a lack of cash flow, as this collateral helps mitigate risk from the lender’s point of view.