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Asset-Based Lending 101
For Factoring and Alternative Commercial Finance Consultants, it is vitally important that you understand the similarities and the differences between factoring and asset-based lending (ABL). Although they are closely related, they are also dramatically different.

Asset-Based Lending vs. Factoring
In the United States, factoring is considered to be a component of the much larger asset-based lending industry. This is exactly the opposite of Europe where asset-based lending is considered an off-shoot of the much better developed and practiced factoring and invoice discounting industry.

Both factors and asset-based lenders finance accounts receivable (invoices) but that's where the similarity stops. Asset-based lenders are true lenders advancing funds and charging interest on those funds. Factors are involved in a purchase and sale transaction and charge a fee based on a discount rather than typical interest.

Even more important is the collateral basis for the two transactions. Factoring is solely based on the purchase of invoices and nothing else. This makes factoring the obvious choice for service companies with little other collateral but a bit lacking for certain manufacturers and distribution companies where asset-based lending better fills the bill due to the advancing of funds using both inventory and equipment as additional collateral sources. Asset-based lending seldom involves real estate.

From the brokers standpoint, it is important to recognize a potential asset-based lending transaction early on to avoid losing a deal when competition is at stake.

Generally:

Asset-based lending transactions will be larger than factoring transactions and typically will involve minimum invoice amounts of $250,000 or more with inventory and equipment adding to that total. A typical ABL deal will be well over $1,000,000 with $5,000,000 being more the norm.
Asset-based lending will almost always involve the need for some amount of inventory financing.
Asset-based borrowers will usually have at least a 3-year operating history at a profit. Unlike factoring, an acceptable level of credit is always a necessity in an asset-based lending deal.
Asset-based lending fees will be substantially less than those for factoring.

For brokers, the general rule is to show all large transactions (those over $500,000) to an asset-based lender first. If they are turned down, then submit the deal to your factor of choice.

Paying of Referral Fees (Commissions)
Another major difference between these two methods of finance is how brokers are compensated for their referrals. Factoring, is of course, the "jewel" of the industry with its method of residual compensation for brokers most often paid for the life of the account. Asset-based lending typically does not share this trait.

Asset-based lenders typically will compensate brokers by paying them a one-time commission based on "points", with a "point" being 1% of the loan face amount. For small ABL deals, a broker fee might typically be 2 or 3 points. For example a $500,000 ABL facility might pay the broker 2% or $10,000 in commission. As deals get larger (and more competitive), the points typically decrease. A $5,000,000 deal, for example, might pay the broker only 1/2 point or $25,000.

Conversion of Factoring Clients
Brokers should always be aware of the potential to convert a manufacturer or distributor that is a factoring client to an asset-based lending client. At some point, it is likely that such a client will be approached by a local bank as they become "bankable". Because of the reduced fees and the ability to finance inventory as well as accounts, the client will quickly make the move from factoring to ABL with a local banker. As a broker, you certainly don't want to lose the monthly income that factoring provides. However, since the transition from factoring to ABL might well be inevitable, you certainly also don't want to miss the final "one-time" fee that asset-based lending offers.

Important Considerations for New Brokers
Those new to the industry may find trouble drawing some distinction between asset-based lending deals and factoring. It is actually very simple. It usually will depend upon the need for inventory finance.

If your prospective client is a manufacturer or distributor and maintains inventory, they are going to require inventory finance at some point and the earlier the better. New operations will most likely not have the credit rating to get ABL in the first year or two of their existence and will need to survive with accounts receivable finance and factoring until such time as they can qualify.

Service businesses do not have an inventory component that requires financing so unless they are very large ($500,000 or greater in sales each month), the deals should be shown to a factor.

So the rule is:
If you are going to prospect in manufacturing and distribution, you better be very familiar with ABL. If you are prospecting in the services area primarily, factoring is a more important product.