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. To overcome such cash needs, most companies turn to a line of credit, which means securing the loan with collateral to obtain this financing. Asset-based lending allows companies to borrow money based on the liquidation value of assets on their balance sheet. Common assets 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 to continue operating. This is because asset-based lending is less demanding than other methods a company 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
Repossession
The chance of losing a valuable asset is always high in such cases. Failure to repay the loan gives the lender the right to repossess the asset used as collateral against said loan and sell it. At times, the lender makes a profit, especially for those assets whose value keeps on increasing, such as land or business premises. A borrower then risks losing a valuable asset that could have been used to bring about business growth soon. Sometimes, the collateral listed may not be enough to cover the default loan. A lender is then forced to seize the borrower’s other valuable assets to fully recover the amount.
Diminishes credit score
When a business reaches a point where it can use its assets as collateral, that strongly suggests it is financially unstable. A good credit score means an entity can 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 collateral performance on an ongoing basis makes asset-based lending labour-intensive. It often requires a significant investment in information systems and specialized personnel with intimate knowledge of the borrower’s business. A borrower will be forced to write reports about the condition of the asset now and then. The lender may even dictate how you are supposed to use the asset to ensure it does not have wear and tear. This process can be long and tiring.
Over Mortgaging
Another significant risk of placing assets as loan collateral is over-mortgaging. Using real estate or land as collateral will result in the borrower owing more on the loans than what they have in equity. If the apartments’ value goes down, the lender will be forced to take more collateral from borrowers 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 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 collateral value. Any property presented as 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 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 increases the cost of the loan. On the other hand, some banks may charge audit fees, diligence fees, and interest rates on loans. When it comes to a traditional loan, a bank only charges the interest rate and nothing else.
Not all Properties/assets qualify
A lender or financial institution mostly wants a borrower to give an asset with a higher value, a low depreciation rate, and easily convertible into liquid cash. This shows that not every asset will meet all these conditions. For an asset to qualify, it must be of high value, low depreciation or high appreciation rate and easily convertible into cash. Those conditions make an asset to be used as collateral for asset-based lending.
