When using collateral for borrowing, it can be costly to not recognize the ramifications of pledging certain assets. This means, once collateral has been borrowed against in the form of a loan, the loan must be paid off in order for the same collateral to be used again. All lenders can quickly ascertain whether a loan exists and what collateral has been assigned. Asset-based lending companies require a first security position on the collateral they are financing. Pre-existing loans or credit activities that have been issued a secured position on collateral make additional funding impossible.
Generally, the problem stems from a line of credit which was used up over an extended period of time. Ideally, a line of credit from a bank should be properly managed and treated like a revolving loan. Money should be taken from the line, but regularly paid back to pay down the line. Having the discipline to borrow and pay back on a line of credit will keep the financial condition of the company sound. This means certain expenditures must wait until profit or other investment is available.
What finally happens with the mismanagement of a line of credit is – the line reaches the maximum credit limit. In today’s lending environment, the bank will be unwilling to extend further credit and probably will change the structure of the outstanding amount into a “term loan.” This means the total amount is due on a monthly installment payment plan, leaving the company with their collateral spoken for and no ability to raise additional capital through alternative sources.
So the critical lessons for using your business assets for growth are:
- Know when the company assets are being used as collateral
- Don’t get caught in a dead end where there is no access to badly needed working capital.