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.

Click Here To Speak To Business Finance Specialist Brent Finlay For All You Business Financing Requirements

Institutional Asset Based Lending

“The continual Evolution of Institutional Business Financing Programs Towards Asset Based Lending”

While asset based lending models have been well entrenched in the U.S. landscape for decades, they are still evolving in the Canadian market place.

This is largely because corporate lending criteria doesn’t work in recessionary periods and post recessionary periods where the economy as a whole is operating at a lower level of performance resulting in poor or suboptimal financial statements in many industries.

Corporate finance lends off of financial statements that show strong cash flow and low debt to equity ratios. During and immediate after a recession, especially one as severe as the current one, hardly any money is being provided from these sources for businesses to operate and in many cases, the money supply is contracted due to risk and perceived risk.

Enter the world of the asset based lender where there is a stronger link between lender and borrower with more established rules for managing cash flow and risk that allows the lender to participate in situations where they would otherwise have to pass.

In the last few years in Canada, all the major banks and several U.S. entrants into the market have jumped into the asset based lending world with some being fairly aggressive with their programs for lending money.

While most of these programs are only focused on loan requirements of $5,000,000 or higher, the advancement of the industry in general is good news for small and medium sized business owners who are scratching their head trying to find a source of capital they can cash flow within the profits available in their business.

Institutional asset based lending can have considerable pricing variations off of prime, but this is still considerably cheaper than what I will all traditional asset based boutiques that start at 18% and go up from there.

The key to getting the money and making it work for you is to take on or evolve your financial discipline so you can make all the rules and regulations with this type of money work. In the end, the discipline that any asset based lending facility injects into a business is almost always a good thing that will help not only with short term survival but also long term growth and prosperity.

From a commercial lenders point of view, the evolution to asset based lending makes a great deal of sense in terms of not only managing risk but being more comfortable putting money out into the market.

I believe asset based lending will continue to evolve in all lending categories and become a more prominent form of business financing for many business owners now and in the future.

Click Here To Speak Directly With Business Financing Specialist Brent Finlay

Asset Based Financing is Bridge Financing

“With Some Exceptions, Asset Based Financing Is Only A Temporary Source of Business Loans”

Unless you’re a fairly large company with substantial profitability and assets, its unlikely that an asset based lending solution is going to be a long term or even a medium term funding solution.

The reasoning is fairly simple. The cost of most asset based lending will either not be affordable long term or will substantially eat away at your profits.

The focus of an asset based lender is to finance assets that either they can control directly or that they can easily set up a clear liquidation pathway to get their money back from the liquidation of the assets.

This specialized form of lending charges a premium for the lenders ability to provide funding in situations where conventional or traditional lenders will not be interested. By becoming focused on a slice of the asset lending market, the lending competition can be very minimal in many locales, creating an opportunity for pricing that reflect the underlying risk to the lender.

If you ask an asset based lender why their pricing may be substantially higher than a conventional financing source, the lender will regularly offer back that you’re renting equity due to the fact that the business does not have sufficient retained earnings from profitable operations or paid in capital to secure cheaper forms of money.

While some may feel this is a bit of a cheeky answer to the question, there is a lot of truth and merit in it as well.

First of all, the next option for financing if an asset based loan is secured will likely be an equity investor or equity injection from the current owners. Any investor will require a return on capital at or above what an asset based lender will be charging.

Second, by acquiring capital in the form of a loan, it can be acquired without diluting ownership and paid back according to an agreed upon repayment schedule.

Which leads us back to bridge financing. Outside of institutional asset based lenders that are priced off of the prime rate, the next best pricing options will need to get comfortable with how they are going to get paid back in one or two years or they won’t fund the deal.

Why? Because they know the cash flow will not be able to handle the higher cost of financing for an extended period of time and that without some realistic transition plan to cheaper money in the future, they will likely pass on the financing opportunity. This will then lead to even more expensive asset based loans that are more closely aligned with liquidation and price their financing accordingly, knowing full well that may of the borrowers will fail to turn the business around or find an exit strategy that will repay the debt.

That’s why its important to only enter into an asset based deal if you can clearly see the other side of the bridge or the probability of getting something in place is pretty high.

Otherwise you’ll on a bridge to nowhere fast when the cash flow can no longer service the debt.

Click Here To Speak To Business Financing Specialist Brent Finlay

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

Asset Based Lending In Vogue

Some would say that 2010 is the year of the asset based lender, or at least that can be what it looks like for a lot of businesses trying to locate and secure financing.

Just to be clear, when I talk about asset based lending, this can cover off a lot of territory including such things as inventory financing, factoring, purchase order financing, equipment financing, private real estate mortgages, and asset based loan facilities that take some combination of receivables, inventory, equipment, and real estate as security.

As compared with corporate finance provided through traditional lenders like banks, the asset based loan providers are much more in tune with how to liquidate assets in order to get loan principal repaid if required.

In a typical, non recessionary market place, there are essentially three different categories of business financing provided by the capital markets to small and medium sized businesses.  The first tier would comprise the corporate financing and small business lending programs provided by banks and larger financial institutions.  The second tier is the business version of the sub prime market that is still institutionally driven, but with a focus on subordinate debt lending and higher risk corporate finance scenarios.  The third tier is asset based lending where lending risk and the related rates are higher than traditional banking rates.

In the current market, the corporate and small business lending is slowly coming back, but remains very cautious.  The sub prime lending tier is pretty much non existent, leaving the asset based lenders as the predominant lending option in many situations.

For the most part, asset based lending is used to finance growth, transition business ownership, and provide bridge funding for companies that have experienced a down turn in their financial performance and have hard asset equity to leverage to cash flow the business until financial results allow the business to return or acquire a lower cost corporate financing solution.

Major banks also have asset based divisions for medium sized businesses that are asset rich and require greater leverage than what traditional corporate financing can provide.  But for the most part, asset based lending is focused on higher risk  scenarios where some amount of operational uncertainty precludes traditional lenders from wanting to extend business capital.

In the current capital market, asset based lenders are seeing loan applications for lower risk scenarios than what they would typically be exposed to due to the lack of financing being provided by the other sources discussed above.

The result has been a considerable expansion of asset based loans particularly in the real estate market where private lenders continue to fill the void created by banks tightening up on their lending activities.

This is a hard transition for most business owners who feel that the economy is climbing out of the recession, but can’t get their bank or traditional lending sources to provide any new capital to their business operations.

For many, turning to a higher cost asset based lender is a hard pill to swallow as they feel their business should qualify for lower cost financing alternatives.  But in the current market, growth and even survival is going to cost more with respect to business capital for many small and medium sized businesses and the sooner business owners make the adjustment, the faster they will be able to get access to commercial financing.

This is not to say that asset based lending is the only solution or best solution, but the current reality is that these higher cost financing options may be the only option available in certain cases, making their consideration more critical to the business owner.

Click Here To Speak Directly With Business Finance 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.

Click Here To Speak With Business Financing Specialist Brent Finlay About Your Business Financing Needs