Emerging businesses may have assets of different types at their disposal but are low on capital and cash. This makes it difficult for them to fully operate without sacrificing some of their potential or foregoing an important aspect of their business.
As a solution, they may have heard about asset-based lending. How does asset-based lending work, and what are its advantages and risks? More importantly, which Canadian laws apply to asset-based lending? We’ll cover that and more in this article.
How asset-based lending works
Asset-based lending is a type of loan, or a line of credit, where a creditor (such as a bank or financial institution) grants a loan to the debtor (the borrower) based on the security or collateral being offered.
“Asset-based lending is financing made available primarily based on the current value of the assets that a borrower grants to the lender as security,” said Andrew Biderman, partner and chair of Torkin Manes LLP’s banking & financial services group.
This is opposed to a more traditional financing arrangement where the financing is based on the borrower’s cash flow or financial performance.
Asset-based lending can also be in the form of:
- personal properties: inventory, equipment, machinery, accounts receivable, intellectual property
- real estate: land, building
Although banks are the most common financial institutions that offer asset-based lending, there are other alternatives such as lending companies. Some of these companies are entirely devoted to asset-based lending.
Because it can supply large loans for businesses, asset-based lending is usually preferred by industries that require larger capital, such as:
- construction
- food
- manufacturing
- transportation
- wholesalers
What is asset-based lending for?
Biderman says that asset-based lending financing in Canada is most commonly based on the following:
- accounts receivable and/or inventory
- marketable securities
- real estate and equipment
For a growing business, including small and medium enterprises (or SMEs), asset-based lending is a great way to start or expand operations and management. Because these businesses may not have a good credit history yet, asset-based lending can be their alternative to get the start-up capital that they need.
The loan from an asset-based lender may be used for:
- hiring staff and for initial salaries and wages
- paying or making deposits to suppliers and other partners
- purchasing new machinery and equipment
Here’s a video to understand more how asset-based lending works:
If you’re interested in the laws on asset-based lending, consulting with a lawyer in your area is your best option. For example, Albertans can talk to the best asset-based lending lawyers in Alberta for local laws that affect asset-based lending.
Collateral and security
In common terms, collateral and security may refer to the same thing —property used to secure a loan, which is required by most creditors.
In securing, when the debtor defaults on loan payment, the creditor may foreclose or acquire the property to satisfy the unpaid debt. In asset-based lending, the collateral or security is the heart of the loan transaction.
Some financial institutions may refer to collateral and security differently:
- collateral: a tangible or intangible property, which can be a real or a personal property, whose value is measurable and serves as a security to a loan
- security: a more general term, which may include collateral among others, to secure a loan (e.g., guarantees)
What are risks and considerations in asset-based lending?
Although asset-based lending may be a better option for capital-intensive businesses, there are still some risks to it:
- type of collateral or security: since this is a major consideration for creditors, it must be of great value and has a high appreciation rate (or a low depreciation rate); as such, not all assets can be used to secure an asset-based loan
- in case of default: the debtor risks losing their valuable assets in case of nonpayment of the loan; as a remedy, agreements on payment extensions and force majeure clauses are included in the loan contract
‘Regular’ loans vs. asset-based loans
These factors outline the ways that asset-based lending differs from regular loans. There are other factors to consider, such as the lending institution and the contract details:
|
|
Regular loans |
Asset-based lending |
|
Security |
Not all loans require security, which makes it faster to acquire a loan, but the amount may be minimal |
A collateral or security is required, which may guarantee a larger loan amount for approval |
|
Interest |
Interest rates are mostly fixed, and can be higher in case of unsecured loans or if there’s no collateral offered |
Interest rates may be negotiated, and may be lower compared to other loans because there’s security or collateral involved |
|
Credit rating |
Traditional loans may focus on the borrower’s credit rating, which is the basis for the loan’s principal amount and interest rate to be approved, especially in unsecured loans |
Asset-based lending may do away with the borrower’s credit rating, because it’s the collateral that is the prime consideration |
Is asset-based lending regulated in Canada?
The legal framework surrounding asset-based lending is made up of both federal and provincial laws. With so many laws to learn, it’s important that borrowers consult with a lawyer to understand how asset-based lending works.
Here are some of the relevant laws that concern asset-based lending:
- consumer protection laws: prohibit illegal practices of financial institutions, and the important details that must be disclosed to the borrowers in personal and commercial loans
- property security laws: require registration of security interests executed on a personal or real property before a provincial registry office
- laws on limiting interest: cover the interest rate that creditors can charge on top of the principal, whether the loan is secured or not
- bankruptcy and insolvency laws: when a debtor becomes bankrupt or insolvent, these laws outline how secured and unsecured creditors are prioritized for payment
Laws on asset-based lending
“In Canada, the laws that govern ABL are the same as those relating to financing transactions generally,” said Biderman. He cited the personal property security legislation of each province and insolvency-related legislation, such as the Bankruptcy and Insolvency Act (Canada).
"Since credit is advanced based on the current value of specific assets, any legislation that could impact the value of those specific assets could also be relevant to a lender.
“For example, in the context of an asset-based lending loan to a forestry business, any legislation that provides a priority claim for certain stakeholders over forestry inventory assets would be relevant to the lender,” Biderman said. He highlighted the Forestry Workers Lien for Wages Act in Ontario as an example of legislation that affects asset-based lending. This Ontario law states that unpaid forestry workers have a priority claim in certain circumstances over the forestry products (the inventory) of the business.
How asset-based lending can work for small businesses
Asset-based lending offers a viable option for Canadian businesses seeking to leverage their assets to fuel growth. By using collateral such as inventory, equipment, or real estate, businesses can access the capital they need to expand operations or manage cash flow challenges. Business owners should speak with legal experts to find out how asset-based lending can work for them.
Want to learn more about how asset-based lending works? Reach out to any of the best asset-based lending lawyers in Canada as ranked by Lexpert.
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