By Marina Joseph – Art in Tanzania Internships
When a business has cash flow problems, it fails to operate efficiently as its financial capacity is not stable. Most businesses to overcome such cash needs turn to the form of a line of credit, which means having to secure the loan with collateral in order to obtain this financing. Asset-based lending allows companies to borrow money based on the liquidation value of assets on its balance sheet. Common assets that are provided as collateral for an asset-based loan include physical assets like real estate, land, properties, company inventory, equipment, machinery, vehicles, or physical commodities.
This method has become one of the easiest ways for small businesses to get quick cash in order to continue operating. This is due to the fact that asset-based lending is not as demanding as other methods a business can use to get a loan. There are several problems concerned with using a title deed as collateral. A title deed is a legal deed or document constituting evidence of a right, especially to ownership of property. The following present themselves as the risks involved
The chance of loosing a valuable asset is always likely in such cases. Failure to repay the loan gives the lender the right to repossess the asset that was used as collateral against said loan and sell it. At times, the lender makes a profit especially for those assets whose value keep on increasing such as land or business premises. A borrower then risks losing a very valuable asset which could have been used to bring about business growth in the near future. Sometimes the collateral listed may not be enough to cover the default loan a lender is then forced to seize other valuable assets of the borrower to recover the amount in full.
- Diminishes credit score
When a business reaches a point to use its own asset as collateral that strongly suggests it is financially unstable. A good credit score means an entity will be able to submit the loan repayment on time. However, even if you repay an asset-based loan on time, it won’t improve your credit score.
- Regular Monitoring of assets
The need to monitor the performance of collateral on an ongoing basis makes asset-based lending labor intensive, often requiring a significant investment in information systems and specialized personnel who have intimate knowledge of the borrower’s business. A borrower will be forced to write reports about the condition of the asset every now and then. In fact, the lender may even dictate on how you are supposed to use the asset to make sure that it does not have wear and tear. This process can be long and tiring.
- Over Mortgaging
Another great risk of placing assets as collateral for the loans is over mortgaging. The use of real estate or land as collateral will result into the borrower owing more on the loans than what they really have in equity. If the value of the apartments goes down, then the lender will be forced to take more collateral from borrower in order to recover their money. For instance, there comes a time when the real estate market experiences a downfall. When this equates with the business failing to repay the loan, then the lender will sell the collateral in question and if not enough cash is yielded to cover the loan does not, then more and more property will have to be seized by the lender in order to recover the money.
- Lower Valuations
A lender looks at an asset and how quickly it can convert to cash which means they will always lower the value of collateral in question. Any property presented as a collateral should be correctly valued with a due diligence process and experts to avoid such practices that hurt the borrower.
- Higher Costs
Compared to traditional loans, asset-based loans do cost more. Some banks or other financial institutions want the borrower to provide very detailed information about the asset being used as collateral for the loan. Business owners are to give very concrete information about the current value of the asset in question and the depreciation rate of the asset. Gathering all that information is an expense on its own and thus increase the cost of the loan. On the other hand, some banks may charge audit fees, diligence fees and the interest rate on the loan. When it comes to a traditional loan, the only thing that is charged by a bank is the interest rate and nothing else.
- Not all Properties/assets qualify
A lender or financial institution mostly want a borrower to give an asset which has a higher value, low depreciation rate and is easily convertible into liquid cash. This shows that not every asset will meet all these conditions. For an asset to qualify, it has to be of high value, low depreciation rate or high appreciation rate and easily convertible into cash. Those are the conditions that make an asset to be used as collateral when it comes to asset-based lending.