In recent years, the overriding opinion on asset-based lending has changed. It is now viewed as a viable and robust financing option. Part of this is due to the current economic environment. The new normal for many acquisitions is to deploy a direct lending formula against assets. An acquisition’s purchase price is often driven off the value of the assets. The other part of the shift is that when the economy struggled, once-strong companies experienced periods of decreased profitability and no longer had access to cash-flow financing on either an unsecured or secured basis. For these companies, asset-based lending has emerged as a favored financing tool to support working capital needs and to expand product lines and markets. Without it, many businesses would be unable to obtain the capital they need to position their companies for future growth and increased profitability.
Understanding asset-based lending
Asset-based lending is, as its name suggests, lending secured by an asset. Typically, this includes a company’s accounts receivable, inventory and possibly equipment or real estate, but it mainly means lending to businesses using assets as collateral that are normally used in typical loans. Asset-based lenders advance against a percentage of the asset values and closely monitor the assets throughout the term of the loan.
By looking at accounts receivables, inventory, equipment and other assets, an asset-based lender can make loans even if a business’s cash flow doesn’t meet traditional cash-flow underwriting guidelines. At KeyBank, the asset-based lending group has different, more lenient cash-flow underwriting guidelines. For example, guidelines permit up to 85 percent of eligible accounts receivable and eligible inventory, based on acceptable appraisals. In most instances, these assets can be easily valued, which allows lenders to mitigate concerns over poor credit ratings or weak earnings. As a result, businesses can obtain liquidity when they need it.
Why companies turn to asset-based lending
Many types of companies can take advantage of asset-based lending, but they are typically asset-intensive firms such as manufacturers, distributors, wholesalers, retailers and certain service businesses. Many but not all are in cyclical or seasonal industries. The capital obtained from this type of financing can benefit companies in a number ways:
- for acquisitions
- for capital expenditures
- to sustain growth
- to recapitalize
- to restructure or refinance
Many companies that turn to asset-based lending do so during times of transition – growth, cyclicality or ownership. It is an attractive financing tool because it carries fewer conditions (also known as financial covenants) the borrower must meet. Also, for companies experiencing growth, their assets, particularly receivables and inventory, are likely keeping pace, which provides more collateral for borrowing. For example, asset-based credit lines increase proportionally with revenue and inventory growth.
Other companies may be distressed and retrenching or they may be seeking to expand by investing in new product lines or through acquisition. In some cases, seasonal business cycles may require investment in inventory in one quarter with little or no income until a subsequent quarter, such as a maker of lawn furniture that must build inventory through the fall and winter but not see sales until spring. Asset coverage in the balance sheet can fill the gap to support a short-term loan, enabling the business to invest in materials and labor to build inventory.
Is asset-based lending the right financing tool for your company?
Asset-based lending is more expensive than other typical loans because of the need to monitor the value and availability of assets. Still, many companies that have tried asset-based lending have found they appreciate the flexibility and liquidity it brings to their business and their ability to manage a variety of situations. They have also found that due to the record-keeping requirements that are tied to asset-based lending, cash management and production cycles often improve. Many clients find that the reporting is a helpful management tool.
Many banks, including KeyBank, one of the largest ABL lenders in the country, offer asset-based lending as a service, thereby keeping the local relationship manager as the point person to interface with the customer and deliver the full financial service menu, from cash management to international foreign exchange and online banking services.
Companies interested in asset-based lending financing should seek a bank that is strongly positioned through:
- Detailed industry knowledge to realistically assess a business’s assets and needs
- A seasoned loan portfolio, which confirms experience and expertise
- An experienced banker
- The ability to be an advocate for the business and support it through good and bad times
Companies should also look for banks that have a variety of product and service offerings to meet their long-term needs. When companies in transition stabilize and begin to grow, they often “graduate” from asset-based lending back into a more traditional financing arrangement. However, from time to time the need to return to asset-based lending may arise.
By developing a relationship with a financial services firm that provides asset-based lending solutions, business can look at their financing needs from a different perspective and find the capital they need to grow when they need it – regardless of the economy and/or cyclicality.