Asset-based lending (ABL) is the dominant form of financing in the non-traditional financing marketplace. According to Thomson Reuters, in 2015, ABL loans totaled US$85 billion dollars in North America.
ABL loans are ideally suited for a business that for some reason does not qualify for traditional bank financing, for example customer concentration, short track record, or credit report issues.
ABL incorporates any type of loan where assets have been pledged as collateral to secure the loan and includes financing products such as factoring and bridge financing.
When approving loans, asset-based lenders are primarily interested in the following 3 key considerations:
1. The Orderly or Forced Liquidation Values of the Assets Being Financed
Asset-based lenders primarily lend against tangible assets or collateral that can be relatively easily sold off or liquidated if the borrower runs into financial difficulty and the lender must seize and sell the assets that were used (pledged) as collateral for the loan.
For assets such as plant, equipment, or real estate; asset-based lenders generally require an orderly or forced liquidation appraisal and will lend up to a certain percentage (often 75%) of these values.
For assets such as accounts receivable (AR), asset-based lenders tend to lend between 60-90% of the face value of the AR, after making allowance for discounts, warranties, and returns. AR insurance can increase this advance rate percentage.
Asset-based lenders do not typically finance assets such as leasehold improvements, prepaid expenses, computer software, or assets that depreciate rapidly in value over time.
2. Business Viability
Many businesses that require ABL financing solutions have hit a bump in the road or are going through a challenging time. As a result, asset-based lenders undertake a careful assessment of the viability of the business.
They typically complete a detailed review of the business plan, assess the adequacy of management, the strength of the accounting/finance department, and the ability of the business to operate if any key employees leave.
In addition, the financing solution provided by asset-based lenders is a working capital solution and as such, they do not generally fund operating losses. Many will want to ensure the business has access to additional debt or equity funding in the event losses are being forecasted.
A due diligence field exam is often a financing condition where the asset-based lender either sends its own or a third party due diligence team in to assess the viability of the business.
3. Exit Plan
ABL solutions are expensive relative to traditional bank financing and are generally designed to be shorter-term solutions (anywhere from 12 to 24 months). Asset-based lenders want to understand before they advance their funds, how they are going to get repaid. Will the business qualify for refinancing with a traditional lender? Does the business plan and cash flow projections support the business reaching this refinancing point? Does management have the skills and the contacts to refinance the business when required?
Insuring one has addressed these three key aspects will dramatically improve one’s chances of getting approved for an ABL financing solution.
Readers should also be aware, however, that not all asset-based lenders are created equal. Some are well capitalized and have funds to deploy, while others tend to only raise funds on a per transaction basis. Using a professional independent advisor to advise and navigate this process can save a business owner many headaches if they select a lender that is not adequately funded.
Adrian Isaacs is the founder and Partner of the Business Financing practice at Farber. His group focuses on arranging innovative financing solutions for small and medium-sized enterprises (SMEs) and start-ups. Adrian can be reached at 416.496.3076 and firstname.lastname@example.org.