Asset Based Lending – An Option for Cost-Effective Capital and Liquidity

Many CFOs view asset based lending as a financing outlet of last resort. While that may sometimes be the case, such a view can lead to lost opportunities. As companies confront the tight credit markets coupled with the potential for weaker operating results, many CFOs now view asset based lending as a viable option to finance operations and growth initiatives. Historically successful companies that have recently experienced losses may find the stringent bank underwriting parameters increases the risk that their existing traditional bank loans may be called and the company may be limited as to qualifying for increased or continued financing. Asset based lending (ABL) arrangements can be an option to be used to retire existing bank debt and provide operating and growth liquidity until traditional bank financing becomes available.

In its simplest meaning, asset-based lending is any kind of lending that is secured by an asset. As such, if the ABL loan is not repaid, the asset is taken. A mortgage is an example of an asset-backed loan. More commonly however, the phrase is used to describe lending to companies using assets not normally used to secure other loans. Typically, ABL loans are secured by inventory, accounts receivable, machinery and equipment and real estate. Asset-based loans are an alternative to traditional bank lending because they serve companies that have risk characteristics that are typically outside a bank’s comfort level.

Secured assets typically have an easily determined fair market value. The financing can take the form of term loans, revolving credit lines and equipment leases. Asset-based lenders are known for taking out tombstone ads to advertise their financing in much the same way as investment banks.

Asset based lending is usually done when the normal routes of raising funds, such as the capital markets or normal unsecured or mortgage secured bank lending is not available or cost effective. This is usually because the company was unable to raise capital in the normal marketplace at a reasonable cost or needs more immediate capital for project financing needs. ABL is usually accompanied by higher interest rates as compared to traditional bank financing. Asset based lending can be an effective source of liquidity and capital for funding ongoing operations as well as special financing needs including:

Acquisition – Asset-based financing is often an efficient means to obtain funding for business acquisitions.

Turnaround Financing – Asset-based lenders are typically accustomed to the bankruptcy process and asset-based financing can be ideal for turnarounds because of its flexibility.

Capital Expenditures – Capital expenditure to acquire and/or upgrade physical assets such as buildings and machinery.

Growth – An experienced and creative asset-based lender can assemble a credit facility that can scale to grow with a company.

Recapitalization – A leveraged recapitalization can be a tool to enable a company to pay its shareholders a special dividend.

Refinancing/Restructuring – There may be situations in with capitalrefinancing or restructured financing may be necessary to create a capital structure that better meets the company’s current and forecasted needs.

Buyout – In a leveraged buyout (LBO), the acquiring company uses the minimum amount of equity to purchase the target company. ABL can provide the leverage to complete the transaction at a relatively lower cost of capital.

Advantages of asset based lending include:

  • Tends to feature fewer covenants with more flexibility than other types of financing.
  • In growth situations, the company’s collateral base (AR, inventory) typically grows enabling additional funds to fuel ongoing growth.
  • ABL can instill increased financial discipline as the company is motivated to increase efficiency of secured AR and inventory via improve collections and inventory turnover.
  • Increased security to the lenders, which can result in more time granted to borrowers to turn a company around in difficult times.

Disadvantages of asset based lending include:

  • Primarily asset-rich companies would likely benefit, while many service companies would not.
  • Asset based lending tends to be more expensive than other types of financing, often three to five percentage points above traditional bank financing. 

Asset based lending can be an effective financing tool in the right circumstances. CFOs need to explore all means to provide cost-effective liquidity and financing for the company’s specific needs. A Harvest CFO can assist your company to determine if asset based lending is a viable option given the state of the company’s capital structure, asset structure, current debt load and current and forecasted operating results.

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