The factoring of accounts receivable and asset-based lending are sometimes confused as one and the same. However, 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, and 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 quick 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, that will affect how much money you are able to borrow through an asset-based loan.
Factoring vs. Asset-Based Lending
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 need to be verified. This can take the lender several days or even 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 factor will remain in contact with your customers since it will be handing collections on the invoices. That means your clients will learn that you are using factoring as a way to fund your business.
Asset-based lending is more private, as there is little interaction between the lender and your customers—that is, 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. The factoring of 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.
The Cost Structure is Different
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%.