Many financing articles feel like they’re written for college students preparing for their final essays. Having to comb through a sea of complicated words is enough to make your head spin, and it doesn’t help you make a decision! This guide is designed differently. It can help you understand the basics of different commercial finance options quickly.
Asset-Based Lending
Asset-based lending is a broad category of loans. Other names include:
- ABL financing
- Hard-money loans
- Bridge loans
- Private money loans
- Fix-and-flip financing
What these options all have in common is that they provide financing based on the value of your collateral.
In case you need a refresher, collateral refers to a business asset that helps to guarantee you’re going to repair the loan. For example, you can offer equipment or real estate as a guarantee.
Loan-to-Value Ratio
With asset-based lending, you get a loan for a percentage of the value of your business asset, usually anywhere from 65% to 90%. This is called the loan-to-value ratio.
If a loan offers an LTV of 80%, you receive 80% of the item’s current market value as capital. For example, if you have real estate worth $200,000, you could use it to get a loan for $160,000.
Alternative Financing
This term refers to any kind of loan, lease or financing that isn’t “traditional.” A traditional loan comes from long-time lenders, such as banks or formal lending institutions. Alternative financing can come from private individuals, small lending businesses, family members or online lenders.
There are several differences with alternative financing. First, the requirements tend to be easier to meet, with lower credit scores and revenue requirements overall. Second, the lender usually has more flexibility to customize terms, so business owners can get a better fit for their cash flow, budget and goals.
Of course, this convenience comes with a cost. Alternative financing tends to have higher interest rates, though less than credit card rates. Business owners often wouldn’t be able to qualify for traditional financing in these situations.
Factoring
When you factor invoices, you sell them at a discount to a lender. In return, you get capital instantly. Usually, the transaction has a cost of 2-3% per invoice. The total cost depends on how long it takes for your clients to pay.
The purpose of factoring is to improve cash flow issues caused by long billing terms. If your business must give clients 90 days or more to pay, factoring can be an excellent solution for restoring your working capital.
