Why Are Asset-Based Loans for Smaller Businesses So Expensive?

An inside look into the cost structure of asset-based loans compared to commercial bank loans, and whether or not predatory pricing practices are at play.

Many smaller businesses don’t qualify for bank financing, their credit scores are too low,
the business is new, or other circumstances place them outside the strict lending parameters
of a bank. Even if a business does qualify for a bank loan, the process may move too slowly for the company’s liking. Thankfully, alternative lenders can provide accounts receivable financing, machinery and equipment loans, purchase order financing, inventory loans, and much more.This type of financing, known as asset-based lending, or ABL, is on the sharp increase.

But why does ABL sometimes seem so expensive?

  •   Is ABL perceived as riskier than commercial and industrial (C&I) loans?
  •   Is this a case of predatory pricing by alternative lenders?
  •   Is this an issue of scale, where larger allocations become cheaper to administrate?

    Comparing Cost Structures: An Inside Look

    Interestingly, the default rates on ABL and C&I loans are actually similar to each other. In both types of financing for smaller businesses, the risk-adjusted premiums are therefore similar too. However, ABL and C&I loans have very different cost structures. The cost of initial underwriting and of monitoring over time is low for C&I loans, while in ABL these costs are much higher. This is because ABL underwriting is more robust, and there is continuous monitoring over the lifetime of the loan.

    In other words, the risk-adjusted interest component in ABL is really modest, just as in commercial lending. It is underwriting and loan servicing costs that drive up the overall cost in ABL. These underwriting and loan servicing costs are more like fixed costs. They are proportionally higher for smaller credits. For larger companies, these costs are amortized over greater financing amounts.

    Is There Any Predatory Pricing?

    There is a common belief, especially among hedge fund managers and sponsors, that there are inefficiencies and predatory pricing in the small business lending space. But they are wrong. What is driving the cost of ABL is a very different cost structure. Lenders in this space need deep underwriting and collateral monitoring experience, and unlike for C&I loans, the specialized task of monitoring assets extends across the loan cycle.

The ABL market is made up of many “pools” of lenders that have different risk appetites. Within each such pool, there is an efficient, competitive environment. But as a borrower, you need to know which pool to “fish” in. Borrowers need to be cautious which group they approach, given the risk profile of their business. This is difficult for an entrepreneur to know, and lenders may not necessarily reveal that they are in the wrong pool for you.

You’ve got new goals for your business

Now that the holidays are behind us, we are enthusiastically focused on the New Year and a fresh batch of goals and resolutions for our business and that’s GREAT!!

You know you are up to the task but is your equipment up to the task?

Sure, your business equipment is working, but is it working well enough to get you to your goals this year? Or is it time to consider an upgrade? Here are a few thoughts that might help you decide if you should modernize your equipment this year.

First, how’s your equipment’s production capacity? If your current equipment is working well, great (but you still might want to consider replacing it).

However, if records or experience indicate that the equipment critical to your business is not quite as productive as it used to be, get together with your dealer to estimate the expected payback time of a new unit with similar capabilities.

Has the cost of consumables jumped since you acquired your equipment, either because the prices have climbed or because your machine is using more than it used to? Would a new unit conserve consumables and lower your costs to achieve a given level of productivity

Consider business equipment operating costs; take a look at the cost of energy, usually one of your biggest equipment-related expenses. Because of recent strides in this area, energy savings alone can often make an upgrade well worth the investment.

Research the advances in new equipment that have occurred since you installed your equipment. New features, added efficiency and greater accuracy can dramatically boost output and quality. Plus, the increased reliability of the new equipment can mean less downtime and lower maintenance costs.

Upgraded business equipment can help you get more from every “live body” hour, further reducing the cost of productivity and increasing your margins without putting extra burden on employees. In addition, the convenience and time savings made possible by new equipment can boost employee morale.

Will updated equipment allow you to offer new products and services? For a restaurant, this might mean new menu items. For a medical office, it might mean in-sourcing tests that would otherwise be performed elsewhere, while a phone system upgrade could make customer self service a reality for a wide variety of businesses.

Would an update help you stand out from competitors in your marketing?

Is new equipment in your business’s future? Get in touch! We’ll help you explore all your financing options.