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Asset Based Loans
“Asset Based Loans – When To Consider Them”
First of all, there can be many definitions of asset based loans.
For this discussion, we are referring to asset based loans in the context of a working capital facility that leverages the equity in accounts receivable at a minimum, but can also provide leverage on inventory, equipment, and even real estate.
The standard asset based loan or ABL type arrangement requires the borrower to open a joint account with the lender and that all funds paid to the business be deposited in this joint account.
The lender will, as they say, sweep the account every day and apply funds coming in to the balance outstanding on the loan. The borrower will request funds from the lender on a daily or weekly basis, depending on the requirements, to pay bills as they come due.
This is a highly simplified overview of how an asset based financing facility actually works from an operational stand point… each lender and financing scenario will have its own unique aspects.
Now back to the original question as to when ABL’s should be considered
There are two basic scenarios (with lots of variation within each one) where asset based loans can be considered to finance business operations.
The two scenarios include situations of growth and situations of financial distress…basically opposite ends of the lending spectrum.
In both cases, what is common is that the business requires high asset leverage to generate the cash needed to operate the business.
Under both these scenarios, conventional lending parameters may not provide sufficient leverage, causing the business to fail outright, or not be able to take advantage of growth opportunities immediately available to the business.
Most asset based loan facilities are born out of the inability of a conventional financing arrangement through a bank or institutional lender to provide the level of financing the business requires.
In highly stable companies with very strong balance sheets and cash flow, the ABL solution can be provided in house through the conventional lenders own asset based lending group. These institutional asset based lenders provide the higher leverage required at slightly higher rates than what their conventional business division would lend money out at. The large bank asset based lending programs are also only going to be available for growth and market development scenarios.
When a business cannot qualify for what we’ll call low cost institutional asset based loans, they turn to boutique lenders that provide ABL services at similar leverage, but at higher rates.
If a business is in distress, the asset based lender will provide higher leverage on assets and very tight cash management to give the business the best chance to turn things around or wind down the operations without destroying equity. Either way, this tends to be a short term solution until the business can once again qualify for a lower cost source of capital.
In situations of growth, the higher cost, traditional asset based lender will once again provide higher leverage at higher rates and serve as the senior lender until the business can qualify for a lower cost form of financing within a manageable range of leverage.
Unless a business is being funded by a low cost form of institutional ABL, the time period of business financing via an asset based loan is typically two or three years as the high cost of financing cannot be sustained over a long period of time in most cases.
Therefore, most traditional asset based loan providers are a form of bridge lender that does not expect to be financing the business into the long term.
Once again, there are many variations to these asset based loan programs, each with their own unique fit in the market place.
To better understand what type of asset based loan facility might be appropriate for your situation, you might consider utilizing the services of a business financing specialist that can help you navigate the landscape.
Asset Based Loan Fit
“When Does It Make Sense To Take Out An Asset Based Loan?”
We are in a period of time where asset based loans have grown in significance due to the more conservative approach currently being taken by banks and institutional lenders.
In most cases, Asset Based lending is significantly more expensive than bank or institutional lending, reflecting the higher level of risk inherent in the business being financed. With greater cash flow comes lower cost forms of asset based lending as well, but for the purposes of this discussion, I’m referring to asset based lending that falls in the 18% to 24% per annum type rate range.
Any business owner will tell you that you can’t function long term on those types of rates and for the most part, they are absolutely correct.
The higher priced, and more traditional form of asset based lending is meant to be short term in nature, dealing with either distress or growth.
In a distress situation where the business is failing, gone through a down turn in the market, or has been unceremoniously dumped by its institutional lender for some reason, an asset based financing facility buys time to either turn things around, wind down, or sell off in a manner that does not destroy value or equity in the process.
For situations of growth, if the growth rate is too high, especially for newer businesses or smaller scale businesses, banks and institutional lenders will shy away from business financing these situations due to risk of the business not being able to properly scale growth and crashing and burning at some point along the way to a better top and bottom line. Once higher levels of sales are maintained over a period of time, then lower cost forms of money will be more than happy to step in and take over the business. They just don’t have the stomach for the potential wild ride that may occur during a growth spurt.
Neither a growth or distress situation can be sustained for any length of time which is why the asset based financing can be a very good fit, even at significantly higher rates of interest than what can be secured through an institutional lender.
In situations where the business is asset intensive and needs a high level of financing leverage over the long term, an asset based financing solution can still work, but its going to have to be a lower cost version which tends to require a minimum facility size of $5,000,000 and strong cash flows and margins to support a lower cost of funds.
Asset Based Loans
“Because There Are So Many Types of Asset Based Loans and Asset Based Lenders, It Can Be Hard To Determine Which One Is Best For A Given Situation At a Given Point In Time”
First of all, asset based lending is all about providing more lending against the available hard assets of a business. The more predictable the resale value of the assets pledged as security, the larger the amount of financing that can be provided by an asset based lender.
Just like all forms of business financing, there are different levels of asset based lending set up according to credit rating and business performance. At the lowest cost level, banks and institutional lenders have asset based lending divisions that focus on providing greater asset leverage to their higher end clients that have an asset intensive balance sheet and require more leverage than what the bank’s traditional corporate finance division can provide to run their business.
The more traditional form of asset based lender focuses on borrowers that do not quite fit the bank’s asset based lending requirements. Slipping into this realm of asset based loans can push the lending rate from prime plus interest into annual rates of 12% to 18%. The cornerstone of these asset based models is the businesses accounts receivable and the resulting cash flow they create.
Still higher priced asset based lending becomes more focused on individual assets , or groups of assets, such as accounts receivable, or accounts receivable and inventory, or inventory only, or equipment, or real estate, and so on.
Sometimes companies with significant assets in all major categories (accounts receivable, inventory, equipment, and real estate) will work with a combination of different asset based lenders to get the best overall leverage and repayment terms.
The challenge with all of this is to locate the most suitable asset based lenders that are relevant to your situation, assets, and needs at a given point of time. In certain cases, the variability among lenders providing asset based loans on certain types of assets can be considerable resulting in borrowers paying higher costs of financing than they need to.
But when time and money are short, its easy to take the first thing that’s available in order to keep the business going and then hope that there is going to continue to be sufficient margin available from sales to pay the higher interest costs and to get the business to a position of profitability that will allow it to return to a cheaper form of debt financing.
The best way to determine what you’re preferred options are at a given point of time is to work with a business financing specialist who understands the current market and lender underwriting.
Click Here To Speak With Business Financing Specialist Brent Finlay
Asset Based Lending Grows In Importance
“Asset Based Lending Has Become a Necessity For Many Small And Medium Sized Businesses”
The recent recession has elevated the importance of the asset based lending market, creating both higher supply and demand in the process.
Asset based lending has a number of different slices, but essentially we’re talking about lenders that have a primary focus on the asset resale or liquidation value for determining loan amounts and security ratios.
Surprisingly to some, major banks also house asset based lending divisions to focus on providing higher leverage to companies with well established cash flows. The bank version of asset based loans are also priced off of the prime rate, making them very rate attractive compared to more conventional asset based lenders.
The growth of this business financing segment has been built on the ultra conservative approach being taken by banks and other institutional lenders. A large chunk of debt financing has traditionally come from small business and corporate banking where the strength and steady advancement of the economy were factored into the lending equation.
But when things turn bad, banks tend to have a harder time realizing on security and getting full loan repayment from asset liquidation. Banks are also not set up to monitor business operations as closely as asset based lenders tend to monitor transactions versus collecting periodic financial reporting.
The extra steps taken by asset based lenders to manage lending risk creates additional cost which is another reason why traditional asset based lending is more expensive.
But even with a higher cost of financing across the board for most asset based loans, business owners are lining up to pay more for their debt financing requirements. And the reason is quite simple. In many cases an asset based loan is all that’s available at the present time.
From a lender point of view, there are more asset based sources entering the market, especially in terms of private mortgage lenders. As the affluent baby boomers grow older, asset based lending provides an alternative to the stock market with solid potential returns and underlying security to protect the investment.
Because corporate or bank financing has contracted for the time being, asset based lenders are also getting a higher quality deal flow than they would normally expect to see, creating competition among lenders for the better deals.
This has resulted in better pricing for the better deals with asset based rates getting close to bank rates in some cases.
Asset based loans have also become a transition step to the future as well. Any business that has suffered through the recent down turn, is trying to expand for growth, or going through ownership transition is likely going to have to look to an asset based loan in the short term. Once earnings stability can be established, they will look to move to lower cost traditional options.
But in the mean time, even at a higher cost, asset based loans are providing essential capital for business operations.
Click Here To Speak To Business Financing Specialist Brent Finlay
Even Higher Priced Asset Based Loans Can Work In The Present Market
The present capital market is more asset based and risk averse than what business managers and owners have gotten used to in recent history. And while a traditional asset based loan costs significantly more than what one would expect from a corporate financing program, the higher rates are something to seriously consider in the current market place.
The recession has created a lot of unfortunate circumstances for otherwise strong and well managed companies. As a result of lower sales, lender demands for repayment of existing debt, or capital required for expansion or equipment upgrades, business owners and managers are now forced to consider options they would never of previously given a second thought to.
But in lieu of where the capital markets are sitting right now, the asset based lenders have become the best option for many businesses, whether the business owner likes it or not.
From the borrower’s point of view, the lending rates between 1.5% and 2.5% per month can seem to be outrageous. But from the lender’s point of view, the rates reflect the risk in the market and are based more on an equity return than a debt return, which relates to the saying that with asset based loans, you’re renting equity as there are no other lower priced debt options.
From a cash flow perspective, the cash based loans tend to be interest only and are short term in nature, not intending to be in place for more than one or two years. So even though there is no principal pay down, the actual debt servicing requirement in the cash flow may actually be less that a lower priced corporate financing deal that requires an amortized repayment.
This is what can make the asset based solution affordable for many companies with asset equity and limited debt financing options. By being able to cash flow the debt service, even at higher interest rates, the business can potentially draw on the capital necessary to main or grow operations until things settle down and better financing options become available.
This is still a better option than selling off part of the company in that the owner has the ability to repay the debt at any time and retain full ownership and control. So like I said, its a lot like renting equity.