Many small and medium-sized enterprise (SME) chief executives and owners previously felt that using this type of alternative finance would create the wrong impression about their business.
One would assume that the business was in trouble if it had to resort to factoring or invoice discounting. This is a perception that has continued into today, with many businesses nervous to accept disclosed facilities where the role of the asset-based lender is identified to its customers.
Asset-based lending is the practice of a finance provider lending a business money against an asset, which in most cases is a sales invoice. The lender will advance an agreed percentage of the invoice to the business when raised. The company will then pay a service charge, which is a percentage of the invoice, and an interest charge of the funds that it is using. When the customer pays the borrower the balance of the invoice is made available.
Primary funding sources
Traditionally, businesses have favoured an overdraft as the main source of funding for their working capital. Now in the current climate, the overdraft is no longer the easiest or preferred option.
The bank will assess the level of risk within a facility and look to cover that risk by taking security either against the business, personally or both. Without security, businesses will find it hard to obtain an overdraft facility. There have been many stories of banks withdrawing overdrafts in recent months because the security in place is not adequate to cover the perceived risk.
In a recent report from the Bank of England, it was revealed that many small businesses are too afraid to ask their banks for additional facilities as they believe this could result in the bank becoming nervous and slashing overdrafts or increasing their interest rates.
So wary are Britain’s five million SMEs that the report revealed they are bypassing their banks entirely and resorting to alternative finance such as invoice factoring. This type of facility has a number of advantages over an overdraft for both the bank/asset-based lender and the company:
- The facility is linked to sales and not the balance sheet or performance of the business. As sales increase the facility is flexible and will grow with the business.
- The facility will be contracted for a fixed period giving a business stability, unlike an overdraft which is always repayable on demand.
- The perceived risk of the facility to the lender is much lower as borrowing is secured against an asset (the sales invoice); as a result the level of security required is reduced when compared with the requirements for an overdraft.
- ABL facilities can normally be approved in a matter of days and implemented very quickly, in most cases far quicker than implementing an overdraft with its security requirements.
- Although the total charges on an ABL facility may be higher than an overdraft, most businesses are convinced that the level of flexibility and reduced security requirements are valuable benefits worth paying for.
For a growing business that needs working capital to expand it is clear that asset-based lending provides a real alternative. The stigma around seems to have gone. At a time when overdrafts are increasingly difficult to obtain or even retain, it seems the once poor relation could be a business owner’s best friend.
