Asset-Based Lending For 2017 And Beyond
Asset Based Lending – The Preferred Solution
Despite the industry’s sometimes negative reputation, Asset Based Lending can be a preferred solution for borrowers who put in the effort to find the “right” lender, with appropriate collateral and loan structure.
The primary difference between Asset Based Lending and Commercial Bank Financing is what the lender looks to first for repayment of a loan. An asset-based lender looks to collateral. Banks look for collateral and covenants.
As access to capital had become increasingly restricted for middle-market companies, many businesses seeking liquidity have begun to see alternative financing solutions, like those offered by online asset-based lenders.
Pre 2010 there was little innovation in ABL; banks continued to offer formulaic, cookie-cutter products that did not accommodate companies with unusual characteristics, seasonal attributes, or atypical business cycles. Asset-based lenders became known as “lenders of last resort,” and the industry was often associated with failing companies and bankruptcy.
Asset-based loans can be a much-needed source of capital for companies that are rapidly growing, highly leveraged, in the midst of a turnaround or undercapitalized. Sometimes a company simply needs that infusion of cash to get over a financial hump or prevent growth from stalling out.
Lenders who provide asset-based credit facilities will work closely with the borrower, working and monitoring the collateral with the client when challenges arise. Clients of asset-based lenders and factors will frequently attest to the flexibility offered by their lenders.
Asset-based lending (ABL) often comes under fire from critics who claim these loans drive borrowers to default, but it can be a useful tool. ABL provides liquidity to both distressed companies undergoing a turnaround process and growing companies looking to expand. It’s more expensive than traditional borrowing, but generally an Asset Based Lending arrangement gives the borrower access to the lender’s expertise – which some midmarket businesses find to be worth the steep price tag, even if they have a number of borrowing options.
A vast majority of those same small business leaders, nearly 80%, indicated that one of the biggest impediments they face in creating new jobs is lack of access to capital. One sector of the financial services industry that did not restrict the flow of capital to businesses during the downturn, and continues to lend to businesses today, is the asset-based lending and factoring industries.
The chances of securing a credit line are only as good as the quality of the receivables. Commercial lenders will sort through your customers to identify the ones that pay in less than 60 days or have a strong credit rating. They may not deem sales to individuals or small businesses as “eligible receivables.”
Asset-based lenders can often provide more liquidity than traditional lenders by using the value of the assets. ABL typically has fewer covenants surrounding financial performance, which can give the borrower more flexibility in operating its business. And asset-based loans can be tailored to meet a company’s specific needs, such as providing increased seasonal advances to help the borrower through a low selling season.
Communication Is Crucial
To determine a prospective lender’s approach to communication, a borrower’s management team needs to spend as much time as possible with the lender, ideally at its office. They should understand the process by which the lender makes decisions, and should get to know as many of the lender’s decision-makers as they can – not just the underwriters, but also the people who make credit decisions after the loan is executed, as these will be their day-to-day contacts. These relationships will help them better understand the lender’s culture and how it operates.
Asset Based Lending lacked innovation in the past, leaders in the sector have begun to evolve in their approach to asset-based loans. Borrowers can distinguish forward-thinking lenders from the old guard by looking at whether prospective lenders value open, two-way communication. Borrowers should look for a lender that truly views the lending relationship as a partnership in which both parties are responsible for maintaining transparency and clarity about their objectives.
One topic that a borrower should discuss with the lender before entering into an Asset Based Lending agreement is the structure of the ABL facility – and the borrower’s management team needs to read all the paperwork.
While traditional ABL is rather commoditized, some elements of the loan’s structure may be critical to the success of the partnership.
Lending on Collateral, Not Covenants
Alternative lenders often have a different approach toward covenants than do traditional lenders, whose covenants are primarily focused on the balance sheet and financial performance. While asset-based lenders may also consider performance-based metrics, they are much more concerned with collateral and liquidity covenants.
Covenants are useful for driving dialogue between borrower and lender, but they shouldn’t be the only driver. At the end of the day, an asset-based lender should focus on the borrower’s collateral and leading performance indicators rather than on financial covenants that may be restrictive or too rigid.
Along the same lines, the borrower’s management team must understand, before entering an agreement, the degree to which the lender is willing to work with them through the flows and ebbs of their business cycle. The purpose of any covenant should be to act as a trigger so that when the borrower reaches a certain point, management must take a “time out” for a dialogue in which the lender can ask key questions and determine next steps.
Asset Based Lending vs Equity Partner
Often, the relevant comparison for the borrower is not ABL lender versus traditional bank, but rather ABL lender versus equity investor.
Thus, when selecting a lender, the borrower needs to pay close attention to the service, flexibility, and responsiveness of its prospective partners, as well as the access borrowers have to decision-makers within the lending organization. An innovative, forward-thinking approach to the lender-borrower relationship can complete the value equation and make ABL’s price worth paying.
CEO & Founder | IMMFinancial.com
Over 20 years of Commercial Finance Experience in Program and Portfolio Management
PMP, PMI-PBA, MBA