Asset-backed Debt Financing


An asset-backed financing is a product whose value is derived from and collateralized (or “backed”) by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets which are unable to be sold individually. Pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization, and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets.

The pools of underlying assets can include common payments from credit cards, auto loans, and mortgage loans, to esoteric cash flows from aircraft leases, royalty payments and movie revenues. A financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, asset-backed securities are an alternative to investing in corporate debt.

BANK VAULTMany private capital investors may prefer to invest in debt rather than in the equity of a company. In return for their investment, the debt is usually secured by some or all of the assets of the company and is traditionally structured as an installment note at a relatively healthy interest rate (most young companies do not borrow money at the same low rates as other companies). This gives the investor the comfort of being a full-fledged creditor, rather than a last-in-line shareholder if the company folds. Further, the investor’s interest income comes off the top, rather than off the bottom, of the profit and loss statement. This is also a plus for many prospective investors because many small companies do not actually generate earnings, at least initially.

Asset backed financing is an effective financing tools for small companies in need of short term capital, but should only be used when the business is capable of making the usually high interest payments from their existing cash flows.