What You Should Know About Asset-Based Lending

When you apply for an asset-based loan, you pledge assets to secure a loan from a bank or commercial finance company. You still own the assets, but if you don’t make good on your payments, the lending institution can seize them.

What is the difference between asset-based lending and traditional bank financing?
The primary difference between the two is what the lender looks to first for repayment of a loan. A traditional bank will look first to the cash flow for the repayment, then to collateral. Therefore, bankers pay close attention to the borrower’s balance sheet and income statement to gauge future cash flow. Since traditional banks underwrite cash flow as their primary repayment source, they typically require less collateral controls and monitoring, but more financial covenants.

An asset-based lender looks to collateral first. For asset-heavy companies, an asset-based loan may make more funds available because it is not based strictly on the anticipated levels of cash flow. Additionally, the structure often requires fewer covenants, providing more flexibility for many borrowers. Asset-based lenders are primarily concerned with the performance of the assets being pledged as collateral.

Many times, companies that require asset-based financing have the assets to obtain traditional bank financing but are too leveraged to qualify.

What is an asset-based loan (ABL)?
An ABL provides businesses with immediate funds and ongoing cash flow based on a percentage of the value of your company’s assets, such as commercial accounts receivable, inventory, business equipment and machinery. This is structured as a revolving line of credit. You may draw down on your line of credit whenever needed and pay back to increase availability for future use. You only pay interest on the funds you have drawn down so overall, it’s less expensive than a term loan.

What type of companies use asset-based loans?
Companies with strong accounts receivable and a solid base of creditworthy customers tend to be the best candidates for asset-based loans. They are particularly among retailers, wholesalers, distributors and manufacturers because these type of companies a.) can benefit from a cost-effective source of working capital, and b.) have specific types of current assets that can be pledged as security. Other companies that can benefit are:

• Companies experiencing rapid growth
• Highly leveraged companies
• Companies with a short operating history
• Turnaround situations
• Companies with negative cash flow
• Companies with past losses

What is the range of funds?
The minimum amount usually starts at $250,000, and can go up to $3 million from commercial finance companies. Larger lenders tend to specialize in financing amounts of $3 million and greater.

What is the principal advantage of asset-based loans?
The principal advantage is the acceleration of cash flow to the borrower to support its working capital needs. By using its current assets as collateral, a company is able to generate cash sooner than if it had to wait for inventory to be sold to become accounts receivable and accounts receivable then to be paid in cash. Cash is available as needed, and any cash not needed on a daily basis is used to pay down the line of credit.

What are the costs?
The costs vary from lender to lender. Traditional bank financing will be less expensive compared with a commercial finance company. Businesses should expect to pay interest rates of Prime + 2-5%. Some finance companies may quote interest rates based on Libor rather than the Prime rate. In addition, most will charge a monthly collateral management fee which can range from .20% to 1%, even if the business doesn’t draw on the line of credit. Most loan costs include a non-refundable due diligent fee once you sign the proposal or term sheet. If a field exam or audit needs to be completed, these can range from $750 on up. At closing, businesses should expect to pay a 1-2% fee on the credit line facility amount.

Generally, business owners will have to provide a personal financial statement and personal guarantees in addition to pledging the assets of the company. The borrowing agreement will usually have contract terms of one to three years and will contain loan covenants that must be understood and followed by the borrower and reviewed on a regular basis. It is very important that these covenants will be obtainable or there could be additional loan fees for being out of formula or covenant compliance fees.

In summary, asset-based lending is ideal for small to mid-sized businesses that have a high percentage of current assets, need working capital to support growth or expand their business, have seasonal or cyclical natures, have outgrown their current lender, or need a more flexible financing solution than what traditional bank financing can provide.

Choosing a qualified asset-based lender and developing a partnership is extremely important to a company’s financial success. Look for a lender who understands your needs as a business owner, not just a borrower. Find a lender who knows the industry and can tailor loans accordingly. Ensure the lender is financially stable. Seek a lender who has access to low cost of funds and use a lender that can grow with the needs of the company.

Cheryl O’Neill Gowen is president and CEO of Alternative Funding Options. She works with business owners seeking cash flow from non-traditional sources, drawing on more than 30 years’ experience in banking, financing and staffing. Contact her at: cgowen@altfundoptions.com.

Article as it appears in the Business Observer.