Sourcing finance is one of the chief priorities for businesses, no matter their size. Capital must be raised for a wide range of purchases, from ordering new equipment, to financing expansion projects. However, this task can be easier said than done. There are just as many methods of raising finance as there are ways to spend it, with some being better suited to some situations than others. What’s more, small businesses are uniquely limited in their options, owing to their limited financial and credit history.

One method of raising finance, a method well-suited to even the smallest of startups, is asset finance. It can be used for a myriad of purposes, and is much more accessible than many other forms of finance. In this article, we will discuss asset finance, how it works, and the advantages and disadvantages of using this form of finance. Let’s get started.

What is asset finance?

Asset finance is a type of secured loan, and an umbrella category of its own. Asset finance loans require assets to be used as collateral, a factor that is significantly more important than most others. This allows borrowers to obtain the capital they would otherwise have trouble securing, due to lacking an extensive financial history or having a poor credit rating. However, they would have to own assets of sufficient value to do so.

How does asset finance work?

Asset finance works in much the same way as any other loan, but with the added element of collateral assets. A borrower will apply for a loan that satisfies their needs, provide the necessary prerequisite information, and the lender will either approve or reject the application. If they approve, they will place a lien on the assets offered as collateral.

Also Read: What Is a Revolving Credit Facility

This lien has no immediate effect; the asset will remain in the borrower’s possession, and they can use it as they usually would. However, if the borrower cannot pay back the loan and defaults, the lien entitles the lender to seize the asset if they so choose. The lender can either take the asset as payment, or sell it off to recover their lost capital. If multiple assets have a lien placed against them, the lender is only entitled to seize assets up to the value of the remaining debt.

Assuming the borrower does not default, they will repay the debt plus interest in installments, just like any other loan. While the use of collateral does constitute increased risk on behalf of the borrower, it does confer some noteworthy advantages.

Advantages to using asset finance

Asset finance has a multitude of advantages to offer businesses. Some of the most notable are:

  • Fast access to finance – Compared to other forms of finance, asset finance can get money into the hands of businesses very quickly. This is due to asset finance being mostly concerned with the value of assets; credit history and the other usual bits of information are not as vital to an application. This can significantly speed up a loan application, meaning capital is raised much more quickly.
  • Inexpensive – Unsecured finance, being loans that do not require collateral, tend to have much higher interest rates than asset finance and other secured loans. This is to offset the risk of losing the lender’s capital, as they will recoup their initial investment quicker as a result of the higher rates. While this is good for lenders, the increased expense is not ideal for borrowers. With asset finance, the collateral acts as insurance enough, removing the need for higher interest rates and saving the borrower money in the long run.
  • Loan value is tied to asset value – As asset finance is built around collateral, the value of these assets is paramount. Amongst other things, this means that the value of your assets determines how high, or low, the value of your loan is. If you own a boat valued well into the hundreds of thousands, that too can be the value of your loan.

Also Read: Invoice Financing vs. Invoice Factoring

Disadvantages of using asset finance

Although asset finance has a series of excellent advantages, it has its drawbacks you should be aware of before taking action. These are:

  • Increased risk for the borrower – While using an asset as collateral does have its perks, it constitutes a risk for the borrower. If you default, you stand to lose whatever you put up as collateral, which could be disastrous for your business if you used its equipment.
  • Low-value assets mean low-value loans – Loan value being tied to asset value is a double-edged sword; it isn’t of much use if you don’t have high-value assets. This might mean that you can’t obtain the capital you need to accomplish your goals, or you’d have to use a multitude of assets as collateral, increasing the risk to your business’s operations if you default. In such cases, unsecured loans might be the better option.
  • Appraisal may decrease the value of your assets – When attempting to obtain asset finance, you will have to get your assets appraised by a professional valuer. This professional valuation can reduce the value of your assets if they determine it was priced too high initially. By the same token, you might find some of your assets to be of higher value than you initially thought. Either way, this does mean an additional risk for you to factor into your decision-making.

Wrapping up

In summary, asset finance is a viable method of raising capital, especially for smaller businesses without the means to obtain other forms of finance. Despite the risk, asset finance can be relied upon to raise a large amount of capital for an equally large number of purposes, whether that be to fund stock purchases or expansion opportunities. What’s more, it is much quicker than many other types of finance, another invaluable quality for small businesses. However, the added risk is not something to be brushed aside; though the advantages are numerous, the risk of using asset finance can be substantial to businesses in rocky financial situations, especially if they use assets vital to operations. As such, it is an option best reserved for businesses with fairly stable finances.