What is asset based lending?
Asset Based Lending
Asset based lending (ABL) or Asset Based Financing is a form of secured lending where a loan is advanced against specific assets of the borrower. The main focus of asset based lending is on assets such as trade debtors, inventory, plant & machinery and property.
An increasing number of medium-sized businesses and larger corporates are turning to asset based lending, either as an alternative to current sources of financing or as part of a wider financing package.
Main types of ABL financing
Accounts receivable/trade debtors
The financing of accounts receivable can be a key component of every ABL facility, usually comprising 60% or more of the overall funding amount. However stand-alone inventory facilities are also available in the market.
Invoices are presented for funding at a frequency to suit you, usually weekly or monthly, with funds being made available at the agreed advance rate, which can be up to 95% of eligible debt.
Inventory (stock)
An inventory facility is structured on a revolving basis, just like receivables are with invoice discounting.
Stock carries a higher risk profile and attracts advance rates of up to 75% of a ‘net orderly liquidation value’ - basically what the lender thinks they would get for the stock in a ‘fire sale’ of the goods.
It is important to note that not every type of inventory is suited to ABL. Eligible inventory is restricted to finished goods and marketable raw materials (e.g. commodities) whilst WIP (work in progress) is usually excluded unless it has some resale value and can be incorporated into another manufacturing process.
Lenders will also exclude inventory which is difficult to sell because it is slow moving, obsolete or subject to the vagaries of fashion (e.g. clothing).
One further potential problem for asset-based lenders arises from Retention of Title (‘ROT’) issues. This affects both goods sold by the borrower to its clients and stock ‘sold’ to the borrower by suppliers. This affects goods on consignment or provided on the basis of sale or return/ approval.
For goods supplied by the borrower to clients, their contract must preserve both legal and beneficial title to the goods until payment has been made, coupled with requirements to ensure the goods are both properly insured and are separately identifiable to preserve the lender’s security. Equally, goods supplied to the borrower which are also subject to ROT will also be ineligible for an advance.
Plant & Machinery
Plant and machinery might attract advance rates of up to 75%, based on the estimated value that could be achieved assuming a disposal within a 3 to 6 month period.
The value of the assets is supported by independent valuations conducted at the beginning and at regular intervals during the life of the loan.
The advance is structured as a term loan in favour of the lender, usually for a maximum term of 5 years.
Advances against P&M will generally amortise fully over the expected economic life of the asset, although it may be possible to structure a balloon payment if the asset has some residual value at the end of the term.
Property
Property (or Real Estate) is relatively straightforward - again, the advance is structured as a term loan with a typical maximum term of 5 years (but with a repayment profile of up to 30 years).
Lenders will vary in terms of what valuation of the property this is based on; for some, it will be the open market value but other lenders will take a more cautious approach and only rely on the vacant possession valuation, net of all realisation costs.
Cash Flow Loans
Most asset based lenders will also offer a cash flow ‘top up’ on the facility to provide additional headroom or meet the required quantum to finance an MBO or acquisition.
These term loans are usually structured on a fully amortising maximum term of 3 years, but some lenders will offer short capital repayment holiday periods of 3 to 6 months.
Who is asset based lending for?
Asset based lending is best suited to firms with large asset rich balance sheets where ideally at least half the assets comprise working capital (trade debtors and stock).
Many of these businesses will typically have low margins and fluctuating EBITDA so cannot get the level of funding they need for working capital on a cash flow basis.
Sectors that are typically well suited to ABL include services, retail, distribution, manufacturing, construction and transport.
ABL can accommodate a very wide range of deal sizes.
Traditionally, smaller corporates were more likely to make use of asset-based lending, with providers more comfortable knowing their loans to smaller, riskier firms had full collateral backing.
However, in today’s market asset-based lending is being widely used by varying sizes of firms in a range of circumstances.
Very large deals are syndicated, whilst small deals are provided on a bilateral basis. Deals falling in the middle are usually clubbed between a small number of providers.
What are the advantages of asset based lending?
ABL usually generates more cash than other forms of debt
You will generally be able to generate more cash through an ABL facility than you could borrow on a cash flow lending facility, for example.
Because ABL facilities are secured on the assets of the company, lenders will be willing to advance a higher level of funds. Cash flow lenders, with more dependency on forecasts, are naturally more cautious.
ABL improves cash flow
As well as being a good way of generating an immediate cash injection, ABL is also a very effective on-going working capital solution.
Accounts receivables will always be the biggest component of the borrowing base, and they are funded on a revolving basis - that is, the total accounts receivable will fluctuate in line with sales and the level of funding available to you will grow in line with it.
As your sales and therefore accounts receivables increases, so does the amount of funding made available to you.
What are the disadvantages of asset based lending?
The amount of funding available to you can reduce too
Whilst you benefit from an increase in sales and therefore an increase in trade debtors with an increase in funding availability through an asset based lending facility, the same is true in reverse - if your sales are reducing, the amount of cash available to you through your ABL facility reduces too.
Administration
ABL can be quite a heavy burden administratively.
This is why it is better suited to established, mature businesses with good systems and controls. You will have to provide good quality management information monthly as a condition of any asset based lending facility.
And, depending on how many asset classes are included in your facility, you can expect the lender to carry out up to 4 asset approvals and audits annually.