When your business needs substantial cash and you’ve tapped out traditional banking as an option for funding, you often need to decide between hard money lending (also known as a bridge loan or asset-based loan) or bringing in partners with equity to fill the gap. Both have their positives and negatives, and in this article, we look at when to harness each.
What is Asset-Based Lending?
Asset-Based Lending, or ABL for short, is a way for companies to obtain funds using their assets as collateral. These assets can consist of accounts receivable, real estate property, equipment, inventory, among others. Asset-based loans are generally used by small or medium sized companies who have untapped capital from their assets. Asset-based lending can take the form of a revolving line of credit for when businesses continually need funding.
What is Equity Capital?
Equity capital is a method of obtaining funds by selling a portion of a business’s ownership. The cash obtained can be used to reinvest in the company and grow it more rapidly. Equity capital increases a company’s cash available without increasing liabilities since no money has been borrowed. Additionally, since it doesn’t have to be repaid like a typical loan, the risk is spread between multiple owners in the case that things go bad for the company. Even though there is no debt accrued by bringing in an investor or partner, profits are divided moving forward and decision making is often shared.
When should my business use an asset-based loan?
Asset-based loans are particularly useful for situations when companies don’t have enough cash on hand to complete a project, when the bank has maxed out funding, or when speed is critical.
You only need cash for a short period of time
Since rates can be higher than traditional lending, asset-based loans work best when there is a short and determined period when you need capital. When working on property development for example, if you know you can refinance out at the end of the project and an asset-based loan will get you to the finish line, it might be worth the higher interest fees as a trade off to giving up equity once you refinance out.
You need financing fast and have an asset
Getting approved for financing can take a long time. The average time it takes to approve a bank loan is more than 90 days, but if your assets have value, you can convert them into cashflow in a few weeks or even days with an asset-based loan. This can mean the difference in purchasing closing a deal on time and missing the opportunity completely.
You don’t want to lose ownership or profits
The adage that equity is more expensive than debt is very true with Asset-Based Loans. If your project has major upside down the line, and you know you can float a higher payment in the short term to reach it, these loans can be the right option for your business.
When should my business use equity capital?
You don’t have any assets
Equity capital can come in handy when you don’t have anything to leverage other than the future wins of the business. Unlike debt financing, equity capital does not come with the risk of losing your assets, but trades that for the risk that your business might be profitable in the future and that will result in larger payments down the road. For very risky or speculative deals, equity could be the only funding option available.
You don’t want monthly payments
Another benefit of equity capital is the lack of a monthly payments. This is important to consider as some companies might not have the necessary cash flows to support these. The funds obtained from selling stock in a company can be entirely reinvested without being tied down to paying back a loan for months.
You’re seeking a partner, not just money
Another excellent reason for seeking out equity funding is to obtain a strategic business partner. It is common for smaller businesses to look for a financial partner who has expertise in the business’s specific industry to invest in their company. This investor can then help it grow fast while also providing longer term funding than a gap loan. This is important because you may also have to share the management decisions of the company with this partner moving forward.
Debt vs equity capital: lottery ticket example
As complex as these two forms of financing can seem, the example below can provide a high-level overview of the pros and cons of each.
Suppose you want to buy a $20 lottery ticket, but you do not have the money to do so today. In debt financing, your friend agrees to give you the $20 today if you pay him back $30 in a week.
If you do not win the lottery, you still need to figure out a way to pay your friend back $30. In the case that you win, you will only ever owe $30 and get to keep any earnings on top of that.
Alternatively, with equity capital, your friend might agree to give you the $20 if you agree to give up half of any potential earnings on the lottery ticket in the case that you win.
If you lose, you never have to pay the friend back the $20 for equity capital since you shared your risk with your equity partner. If you win, however, 50% of your earnings will be theirs which would be much larger than the $30 in the loan option.
How do asset-based loans work at Cultiva Financial?
With an asset-based loan from Cultiva Financial, you have the option of structuring your monthly payments as interest only, at rates of around 10-17%. The principal does not need to be repaid during the term; it is paid at the end. If a business decided to pay off this loan early, we do not penalize them for doing so, unlike other companies. Additionally, we don’t require first lien position to approve an asset-based loan when many other lenders would, allowing you to use ABL as an extra source of funding for your project.
The factors that determine whether a company will be approved for up to 5 million dollars in ABL include the property value, previous payment history, and the profitability of the business, among others.
What you need to apply for an asset-based loan?
To apply for ABL, a business would need to fill out our simple online application. They would identify which assets they could use as collateral to obtain these funds. We then review the application and create a structure that can best meet the client’s specific needs. Once the funding is approved and the paperwork is signed, the funds are disbursed. Not only is our overall process much faster than the search for investors, but the overall experience is more flexible as well. We help you improve your cash flows and balance sheet so you can quickly focus your efforts on business growth.
Ultimately, both debt and equity capital are tools used for companies to obtain funding to satisfy cash flow disruptions and to promote business growth. They are often used together in a way that makes sense for each company. Since both have distinct benefits, it is up to the company to determine what combination best makes sense for their situation.
To find out more about the specific documents that are required to apply, as well as the factors that can affect approval and rates, check out our webpage here.