Understanding The Risks Involved In Hard Asset Loans

November 2, 2022

Companies who are low on cash flow can experience difficulty in running the day-to-day operations needed to stay in business. As such, it may be necessary to seek an infusion of money, and so, applying to borrow funds is a feasible strategy. 

Where hard assets come into play is because a firm may not qualify for credit due to circumstances, such as bankruptcy or foreclosure, that render them more high risk. The lender, therefore, issues the loan based on hard assets as collateral. The criteria and costs are similar to that of a bridge loan, as it is temporary in nature and assumes the company will enjoy a future spike in profits.  

Hard assets are divided into two types: fixed and short-term. Fixed assets are those that have a duration of greater than one year, and these also tend to fall into one of several genres: property, plant, and equipment. These can be but are not limited to buildings, machinery, fleets of vehicles, and furniture. 

Hard assets that are short-term, also referred to as current assets, are those resources used up more quickly and that help a company produce revenue, and inventory tends to fall into this category. These also are defined as tangible items that have the expectation to generate value at some point in the future.

The most obvious risk to taking out a loan of this kind is the consequence if you should happen to default on the note. It means that the very structure of your business is in jeopardy and that you may go under should you experience trouble returning the money. It is important to carefully assess the feasibility of making payments along with the market forces you are under. 

There is also the fact that your asset-based loan is going to carry a higher price tag than will one based on a traditional model. More paperwork to determine creditworthiness will be needed and is a part of the reason these financial instruments cost more. 

Detailed documentation regarding the nature of your assets will be necessary, as the calculations by which their value is determined will be complicated. It involves figuring out what they are worth as raw materials versus what their potential is in terms of your business. These costs may be assessed in the form of higher interest rates, and it is possible you may be charged audit and diligence fees. It may be more time consuming on your end to gather all the necessary items as well. 

Also consider that your assets may receive a low valuation, because the bank will determine the turnaround rate for liquidation. Their focus will be finding which items can most quickly be converted into cash, and this translates into a lower assessed value. This can result in the lender making a profit in the event they are able to sell for more than the asset was procured. 

Appreciation rates can also factor in these equations, although this will not equate to a higher loan amount for the business owner. The limit imposed will continue in place despite any possible windfalls, as the bottom line is the lender’s security in extending credit of this kind. You can expect your quote to always be less than the market value of assets, so take this into account when estimating how much you will qualify to borrow. 

AI Capital Advisors helps companies looking to obtain funding by providing oversight to hone and present the best materials possible. Reach out to us for more information, and we look forward to working with you. 

Photo courtesy of Pexels

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