A CFO’s guide to asset-based lending

ABL is a revolving line of credit based on a business’ accounts receivable, inventory, or other approved collateral.

INTRODUCTION

For seasonal businesses, companies going through explosive periods of growth, or organizations otherwise in some form of transition, traditional lending options aren’t always viable. Bank loans and other established methods for securing capital can be too restrictive and can require a pristine operating track record that companies in transition often lack. The answer to the cash flow concerns of many organizations, especially asset-heavy organizations, is one type of alternative financing called asset- based lending (ABL). 

ABL is a revolving line of credit based on a business’ accounts receivable, inventory, or other approved collateral. Businesses can tap into these resources to facilitate expansion or get over a hurdle, such as an unexpected downturn in sales or loss of a key client. These solutions can also fund growth initiatives or even replace an existing line of credit. While many finance chiefs are well-versed in traditional lending sources, ABL may not be part of their usual playbook when evaluating funding options. Or, they may have outdated ideas about non-traditional lending being out of reach due to high fees and burdensome reporting requirements.

 This white paper will discuss the details of asset-based lending, tips for evaluating if it is the appropriate option for your business and situation, and strategies for finding the right alternative funding partner. 

Questions covered include: 

  • What do CFOs need to know about asset-based lending?
  • How does it differ from traditional lending?
  • When is ABL the right funding option for your organization? ABL can help in a variety of situations, including seasonal businesses and those that need to free up debt capacity, support a turnaround, or fund an expansion.
  • What are some of the key things finance executives should ask lenders about alternative financing to maximize the potential for smart and sustained growth?

WHAT IS ASSET-BASED LENDING?

Asset-based lending is a form of commercial financing that focuses more heavily on the value of a company’s assets to establish lending availability. Various company assets can be leveraged as collateral, including accounts receivable, inventory, machinery and equipment, or real estate. Although traditional lending may also require that these assets be pledged as collateral for a commercial loan, the emphasis for justification of a traditional commercial loan is placed primarily on financial ratios that are heavily driven by company profit and loss performance. Traditional lenders are less forgiving of performance hiccups, fluctuations, high risk industries or anything outside of the box such as atypical customer concentrations. 

Because ABL lenders have deep knowledge and resources to determine asset values, they are able to finance many special situations that fall beyond the scope of traditional lenders. There are a number of instances in which ABL is a good financing alternative. In particular, this type of financing can help companies that are experiencing some type of disruption, including restructuring, turnarounds, refinancing, recapitalization or rapid growth. It is also an attractive option for early stage companies that are not yet profitable

In addition, ABL is a popular solution for private equity firms supporting their portfolio companies during a transition. Private equity managers value flexibility and the ability to provide quick finance, key attributes of ABL. The regulatory environment makes it more labor-intensive to close a loan through a commercial lender, hampering the quick turn-around often sought by private investors looking to capitalize on opportunities. Companies with negative metrics – such as poor cash flow or income ratios or a seasonal/cyclical sales cycle — can also benefit from ABL solutions. ABL lenders are familiar with these challenges and have helped others overcome these hurdles to profitability. 

Unlike traditional financing options, asset-based lines of credit are established based on what is referred to as a “borrowing base.” The credit line is set at a certain level, and the amount that can be borrowed under that level at any given time is dictated by the “borrowing base” calculation. ABL lenders evaluate all assets that can be used as collateral — including accounts receivable, inventory, and equipment — and apply an advance rate against the eligible assets. Advance rates vary by type of asset. Borrowers are required to periodically submit a “borrowing base certificate,” which is their calculation of the value of the eligible assets used to secure the credit line. The borrowing availability under the credit line is adjusted based on the current value of the assets as calculated on this “borrowing base certificate”.

 Non-traditional lenders can offer more flexibility in structuring asset-based loans because they are not regulated in the same ways as other financial institutions. “Non-bank lenders can offer more creativity and more flexibility in structuring an asset-based loan or other lending option,” said Scott A. Winicour, CEO, Gibraltar Business Capital, a specialty finance company. Banks typically have tighter terms regarding loan limits, liquidity, repayment schedules, and other special covenants tied to the debt. “A bank may require a personal guarantee of the loan, whereas an alternative financing company will often forego that requirement,” Winicour noted.

WEIGHING COSTS VS. BENEFITS 

ABL loans through a specialty lender can be more costly and time consuming to manage, which are factors that CFOs need to consider when evaluating funding options. “There are often commitment fees and more frequent reporting requirements, as the lender wants to keep a closer tab on the value of the asset that they are lending against,” said Lisa Kaplowitz, a Strategic Advisor in the value-creation advisory practice at Caldwell Partners and a Professor at Rutgers Business School. “If you have customers that pay on time, are able to turn inventory, and if there aren’t other funding options at better terms, ABL can be an important resource.

 Alternative financing can help a manufacturer or a young company tap into funds at critical moments where they need to get over a hurdle or fund growth.” While costs for financing through alternative lenders are typically higher than loans through commercial banks, non-traditional lenders typically offer more liquidity, industry expertise, and fewer restrictions. “CFOs should certainly be sensitive to costs when evaluating ABL options through specialty lenders, but they will get greater value and access to professionals who are familiar with their industry and challenges,” Winicour said. “Extra liquidity can make all the difference, from having the cash on hand to make payroll to being able to hire a new salesperson who wasn’t in budget.”

 Companies leverage ABL to help them overcome a variety of circumstances — temporary sales downturns, industry upheaval, unbilled receivables — but one of the most critical uses of ABL is to support expansion. “ABL provides value for companies seeking to leverage growth opportunities that cannot normally be financed through traditional lenders,” said Scott Shapiro, Senior VP, Gibraltar Business Capital. Some examples of how organizations have used ABL to finance rapid growth: A private equity group used an $8 million facility to finance the acquisition and ongoing operations of a grocery and food service product distributor, allowing for the implementation of growth and efficiency plans. A private-equity owned snack food manufacturer quickly doubled its initial $8 million in financing to $16 million to support the company’s quick growth. A distributor of lumber and building products was able to capitalize on strong sales growth despite being in a cyclical industry with $16 million in financing.

In addition to helping finance growth, organizations also use ABL to navigate industry transformations. Some recent success stories include:

  • A provider of drilling services for oil and gas wells was able to power through some dips in the oil industry with a $9 million ABL.
  • A media technology company was able to leverage $9 million in assets to more effectively compete in a demand-heavy marketplace. Structuring the terms of the ABL to include unbilled invoices provided the company with some breathing room on services that had already been delivered but were yet to be invoiced.
  • A retailer that had recently doubled in size through an acquisition was able to leverage a $9 million ABL to manage through the integration and operational streamlining of the acquired company.

FINDING THE RIGHT ALTERNATIVE FINANCING PARTNER 

Once you’ve determined that alternative financing is the right choice to help your company through a cash flow challenge, or to capitalize on a growth opportunity, industry expertise is an important consideration when evaluating lenders. “The best advice I have is to look for a lender with experience in your industry who understands the types of challenges that your business is facing,” said Kaplowitz. “Customer references are key, as you want to know that the lender is familiar with the ups and downs of the market you’re in, be it retail or manufacturing or other business.” Kaplowitz also suggests ensuring that you have a complete understanding of the lender’s reporting requirements. 

There is typically frequent reporting on the value of the assets used to secure the loan, she noted, but the processes can be streamlined and automated to reduce the burden. The CFO should also inquire about the typical advance rate based on the company’s various types of collateral, as well as whether there are any exclusions. Depending on the lender, certain types of collateral could be excluded from the valuation and borrowing base calculation, for example, foreign accounts receivable. 

Timing should also be part of the discussion with a specialty lender. “Companies are often seeking out this kind of funding to meet a short-term challenge, so you don’t want a long approval cycle,” Kaplowitz said. Hand in hand with that consideration is understanding how the company makes credit decisions and manages portfolio loans on an ongoing basis. Large companies with onerous committee approvals may be less flexible and timely than those with easy access to senior decision makers.

CONCLUSION: ABL CAN HELP COMPANIES WITH CASH FLOW CHALLENGES AND GROWTH PLANS

There is a perception among some financial professionals that ABL is a last resort. While it is true that ABL can come at a higher cost than traditional funding sources, and often requires more frequent asset reporting, it is a viable alternative for companies that find conventional financing options unavailable or the terms unattractive. Banks can be reluctant to lend to unprofitable compa- nies or businesses experiencing a high level of growth. When they do so, the terms can often be restrictive and prevent the company from unlocking value. “When you find that you’re running your company to appease your bank, rather than to meet your business objectives, alternative financing can be a great way to improve liquidity and solve for short-term challenges,” Gibraltar’s Shapiro concluded.

Key takeaways from this white paper:

  • ABL can help companies overcome cyclical financial hurdles, such as seasonal sales, but it is also an option to finance growth. Commercial banks require financial performance minimums that many companies in these situations lack.
  • While costs can be higher and the lender’s reporting requirements may be more frequent, alternative financing can help companies manage through a transitional period and stay competitive.
  • CFOs should seek out a specialty financial firm with experience in their industry or in the specific situation they may be facing —one that will provide the personalized service needed to help the company get to the next level.

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