Asset Based Loans
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What is Asset Based Lending?
Commonly referred to as asset-based loans (ABL), asset-based finance is a form of business lending that relies on the collateral of your business, rather than just cashflow and credit. Conventional loans look at cashflow first, collateral second, while asset-based loan programs look at collateral first and cashflow second. Relying on the collateral to provide financing allows for businesses that are growing rapidly to maintain the liquidity needed to keep up with capital requirements. While ABL is great for high growth companies, it’s also great for companies that have stable growth or are in distress and need to recapitalize their balance sheet. In most cases shifting existing term debt into a formulaic assed based line of credit will result in improved cashflow and more liquidity for the business.
Use your business assets for working capital
Unlock tied up equity
Increase your line of credit
Borrow against your assets
Improve your balance sheet
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What are the different types of Asset-Based Lending?
There are two main types of assed backed loans, an asset-based line of credit and an asset-based term loan. Asset-based line of credits are structured as revolving credit lines that utilize the underlying collateral to provide financing. Some collateral that is used has a fixed value such as machinery and equipment, while others are constantly churning, such as inventory and receivables. Having a fixed collateral value on machinery and equipment will give a constant amount of liquidity on the revolving line of credit while the churn of both inventory and accounts receivable will provide a varying amount of liquidity. When more inventory is purchased, and new sales are made, the collateral value increases which will result in more capital being available on the revolving credit line.
Asset backed term loans use the same collateral as an asset-based line of credit, but instead of the facility being a revolving credit line, it is structured as a term loan. The term loan can amortize over a period of 1 to 5 years with monthly principal and interest payments. By utilizing collateral that has a fixed value, such as real estate, machinery, and equipment, we are able to provide high loan to values with low monthly loan payments.
Why would a business use an Asset-Based Loan?
Refinancing existing debt to improve cashflow
Raising capital to expand the business and purchase inventory
Business cashflow alone won’t support a loan and the bank needs additional comfort
Raising capital for business acquisitions
Pledging collateral can replace the need for a personal guarantee
The 5 reasons above are just a few of the reasons why a business would use an Asset Based Loan. Overall the purpose of an Asset Based Loan is to turn the assets on your balance sheet into cash to use in other areas of the business.
Rapidly Growing Company – Companies that are growing at a high rate are always constrained by the capital that’s available to them. High growth means more sales, and more sales means more invoices. With invoices or A/R being the primary asset used in asset-based financing, the more a company sells, the more invoices are created, and the more A/R there is for an asset-based lender to lend against. With more sales also comes the need to purchase new equipment, machinery, and inventory, all of which are collateral that can be used by an asset-based lender.
Stable Company – A stable business can still see a tremendous benefit from restructuring debt into an asset-based loan. Often times stable companies have traditional or conventional loans which have low interest rates, but tend to offer limited liquidity and can actually restrict the growth of the company. By using an asset-based loan the company can leverage inventory, equipment, and A/R that might not be encumbered by their existing conventional loan program.
Distressed Company – When a business is experiencing hardship and doesn’t have the cashflow to support traditional loan programs, an asset-based loan is a perfect option. Utilizing an asset-based line of credit that requires interest only payments has a positive impact on the company’s cashflows. Distressed companies with historically tight cashflows have a hard time servicing both principle and interest payments, which is why an interest only ABL revolver is a beneficial solution.
What type of collateral is used for Asset-Based Lending?
Asset-backed loans enable companies to utilize a variety of collateral options for security. Although there is a long list of collateral options that can be used, there are some that are weighted more heavily than others.
Accounts Receivable (A/R) – Once services have been rendered and a sale is official, an invoice is created and sent to customers. For a majority of asset loans the invoices of a business are the primary asset that secures the asset-based line of credit or asset backed term loan. The LTV or loan to value can range, but average advance rates are 90% of the invoice amount. There are numerous items that affect the advance rate on an invoice. Some of these variables are the time it takes a customer to pay, payment terms that product is sold on, credit strength of each customer, and the concentration or diversification of your customer base.
Inventory – Inventory is a core asset that can be used when looking to collateralize an asset based loan. It’s common that business owners will value inventory at retail, but any asset based lender will look to understand what they can sell inventory for in the event of a default. The advance rate on inventory ranges depending on a variety of factors. Some of those factors include the location of where inventory is stored, the type of goods, and how easily inventory can be sold if needed. It’s also important for companies to have a perpetual inventory system to monitor inventory levels.
Purchase Orders – A common asset used in asset backed finance are purchase orders or PO’s. When a customer places an order they issue a PO which outlines the order. The purchase order will show the order date, when goods are to be shipped, the quantity, price per unit, etc… When a PO is received by a seller an asset based lender will review the terms to understand who the customer is, the credit worthiness, and the value of the PO. The loan to value for purchase order financing ranges between thirty to forty percent and as soon as the goods are shipped and an invoice is created, the additional availability will be released.
Machinery and Equipment – Considered a hard asset, machinery and equipment are favorable assets for assed-based lenders. By taking the make, model, year, and the condition of the equipment a lender will have the ability to assign a value to the equipment. The typical advance rates or LTV assigned to equipment and machinery is 60% of the FLV or forced liquidation value. This means that the lender will provide availability based on what they would be able to sell the equipment for in the event of a default.
Commercial Real Estate – Although commercial real estate or CRE is a hard asset and a great form of collateral, it’s not as liquid as equipment, A/R, or inventory. In most cases CRE will be used as an additional asset to provide added liquidity on an asset-based facility, rather than the primary asset used to secure the loan. For example, if you were looking to borrow $5,000,000 from an asset-based lender and only had enough A/R and Inventory to get to $4,000,000, an asset-based lender would look towards your commercial real estate as collateral to provide you with the additional $1,000,000 of availability.
Marketable Securities – Although not a core asset for asset based lending, marketable securities can be used as boot collateral. Securities are often highly liquid and provide lenders with collateral that can easily liquidated. Some examples are bonds. certificates of deposits (CD), or publicly traded stocks. Advance rates range depending on the strength of the security and can be anywhere from 50% to 95% of market value.
Intellectual Property – IP is another asset that can be used in a borrowing base calculation but is very seldom used as standalone collateral. Since IP is an intangible asset, it’s very difficult to truly assign value to it, which means it can be used to help an asset-based lender provide a marginal increase of liquidity, but will never make up a substantial portion of the collateral base.