There are some important differences between Asset Based Lending and Invoice Factoring, often referred to simply as “Factoring”. For many borrowers, however, the differences may not be relevant and conventional wisdom about their differences can be misleading. This post summarizes key similarities and differences to help borrowers find the best financing solution for their business and to help trusted advisors guide their clients.


What is Asset Based Lending?

Asset Based Lending is working capital received from a finance company or bank in the form of a loan collateralized by business assets such as accounts receivable, inventory, equipment and/or raw materials. The assets levels are monitored frequently by the lender and availability varies bounded by current asset values and facility limits.

What is Invoice Factoring?

Factoring is working capital a business receives by selling its accounts receivable to a factoring company or bank. Availability is explicitly tied to the individual invoices.

How are Factoring Companies and Asset Based Lenders Similar and Different?

Unlike the banking world, specialty finance companies operate in an unregulated, very entrepreneurial environment and they vary considerably in the techniques and processes they use to provide financing. Whether that makes one more valuable than the other to a borrower must be examined on a case-by-case basis but there are some reasonable generalities that make them same or different. Some finance companies provide only invoice factoring services, some provide only asset based lending (ABL), others may offer both, depending on the needs and strength of the borrower.

  1. Accounts Receivable as the Preferred Collateral: Factoring services are based only on accounts receivable and most asset based lenders consider accounts receivable preferable assets even if they will lend on other assets as well. Both usually require that payments from the borrower’s customers be assigned to a lockbox. And both usually require that they be permitted to routinely verify invoices with the borrower’s customers. An asset based lending facility often requires periodic audits in lieu of, or in addition to invoice, verifications.
  2. Other Collateral: Even though they nearly always prefer accounts receivable, a true asset based lender may also provide lending supported by other assets such as inventory, equipment, work in process, or real estate. An asset based lender’s preference for accounts receivable can be observed in loan to value (LTV) ratio they provide on different types of assets. LTVs are commonly 75% to 90% on accounts receivable but usually drop to less than 50% on assets such as inventory, equipment and work in process. 
  3. Which is Cheaper? Some people think asset based lending is less expensive than invoice factoring. This is very misleading. Fees and the way they are charged vary widely between asset based lenders and factors. For that matter, costs vary widely between different factoring companies and between different asset based lenders. The best factoring companies are very competitive in price with the best asset based lenders on business that works well under a factoring model.   Factors process and advance upon each invoice individually as they are billed and submitted for financing.  Asset based lending normally works with advances periodically against a ledger of invoices or “borrowing base”.  So a borrower with many invoices and/or many customers may find that asset based lending is cheaper.  Conversely, a borrower with relatively few invoices and customers may find the periodic audits make asset based lending more expensive than a good factoring service. Doing an accurate “apples to apples” comparison of alternative proposals can be quite a challenge. So, it is important for borrowers to turn to their trusted advisors to help them sort out which is best.   Some large banks provide asset based lending services that in today’s market are competitive with the best conventional bank rates.  However, these very low rates are only extended to larger borrowers that probably would qualify for as much or nearly as much credit in a conventional banking relationship.  
  4. Which is Easier?  Again, because factors often handle each invoice as a discrete asset whereas most asset based lenders roll them together and fund on a “borrowing base”, borrowers with many smaller invoices and/or many customer relationships would likely find asset based lending is less paperwork and therefore an easier relationship to administer.  But just as with the costs, borrowers with fewer invoices to handle may find the audits typically required by asset based lenders to be more time consuming and inconvenient than handling a few invoices.
  5. Other Assets?  If the borrower has real estate, equipment, finished goods or raw materials inventory on which they need to borrow, then they should explore asset based lending services. Asset based lenders often loan on these other asset classes but most want this other collateral to support a relatively small part of the loan.  Most prefer the relationship be primarily supported by accounts receivable.
  6. When Does It Make Sense? Factors and asset based lenders are both more expensive than conventional bank loans but are often easier and quicker to obtain and can often supply more financing. Factoring companies and asset based lenders typically can help businesses that are just starting up, rapidly growing, capital constrained, short on the fixed assets that banks prefer, or suffering a temporary financial adversity and therefore are not conventionally credit worthy. Consequently, factors and asset based lenders are typically not a competitor to a bank but rather a solution when banks cannot provide sufficient credit. If a borrower’s profit margins are significantly greater than the higher costs they would pay for the financing, it is better to use invoice factoring or asset based lending than to miss out on profitable growth opportunities.

Summary

Businesses seeking non-bank financing should not go into their search with any pre-conceived notions about whether a factor or an asset based lender would be a better solution. The only way to really know is to shop and carefully compare formal proposals. This whitepaper has addressed traditional factoring and asset based lending models but increasingly there are providers that fall somewhere in-between. Factoring companies add features that look and operate more like asset based lending and vice versa. Borrowers should look only at strong, capable, well-regarded providers and choose the one that can get them the money they need for the best price and the least effort.