Summary: Larger construction subcontractors can be good candidates for asset-based loans. They typically have a strong client base and a good asset mix. However, finding an asset-based lender that works with subcontractors can be challenging. There are several reasons for this.
This guide breaks down asset-based loans, detailing their structure, qualification requirements, alternatives, and lender evaluation criteria. It will help you determine if an asset-based loan is the right solution for your company. We cover the following information:
- What is asset-based leading?
- How does it work?
- Qualification requirements for construction companies
- Costs and pricing
- Lender concerns
- Alternative products
1. What is an asset-based loan?
An asset-based loan (ABL) is a comprehensive product that enables companies to finance various types of assets. Companies typically use them to finance their accounts receivable, as well as machinery and equipment.
Asset-based loans can be used to streamline cash flow, improve operations, and grow the business. They are well-suited for larger small businesses and middle-market companies.
These facilities can work well for construction subcontractors for two reasons. Subcontractors typically have the right asset mix to qualify for an ABL. Additionally, ABLs have simpler qualification requirements and fewer covenants than a comparable bank financing line. Read “Navigating Asset-Based Loans: Small Business Guide” to learn more.
2. How does an ABL work?
Asset-based loans are structured based on the underlying assets that support the facility. Lines secured by current assets, such as accounts receivable and inventory, are typically structured as revolving lines of financing. On the other hand, lines secured by fixed assets (e.g., machinery) are structured as term loans.
Subcontractors that want to finance both current and fixed assets receive one facility per asset. A revolving facility for the current assets and term loans for each fixed asset they want to leverage.
The following table illustrates the typical structure of various assets.
| Asset | Structure |
|---|---|
| Accounts Receivable | Revolving Line |
| Inventory | Revolving Line |
| Equipment | Term Loan |
| Corporate Real Estate | Term Loan |
a) A/R and Inventory
Lines secured by accounts receivable allow you to finance 70% – 85% of your accounts receivable, up to your credit limit. Similarly, inventory lines allow you to finance 50% to 70% of their Net Orderly Liquidation Value (varies).
The line is managed using a borrowing base certificate. The borrowing base certificate tracks the line’s balance, open invoices, and other relevant criteria to determine availability.
b) Machinery, equipment, etc.
Lines that are secured by fixed assets operate as a conventional term loan. The lender allows you to leverage a percentage of the asset’s value. The balance is typically amortized over several years.
Read “What is an ABL? How does it work?” to learn more.
3. Qualification requirements
One advantage of asset-based loans is that they have simpler qualification requirements than comparable bank financing lines. The qualification requirements focus on three areas.
a) Minimum revenues
Asset-based lenders typically work with subcontractors whose annual revenues exceed $12 million. Smaller companies should consider the alternatives discussed in section 7.
b) Financial controls
The subcontractor should have a dedicated finance department that handles accounting, invoicing, and related functions. The finance team should be able to provide accurate and timely financial reports to the lender. These are necessary to manage the line and ensure compliance.
c) Qualifying assets
Asset-based loans are available to subcontractors that have the following assets:
- Accounts receivable
- Machinery
- Equipment
- Corporate real estate
Note that most ABL providers won’t finance only fixed assets (e.g., machinery only). They require that all lines include your A/R as part of the facility.
4. Costs and pricing
The cost of the line is typically determined by its size, complexity, risk, and overall market conditions. The line’s size is usually the most significant factor that affects the cost. However, complexity can have a significant influence, especially if it increases risk.
a) Due diligence
The due diligence process allows the lender to examine the company and its assets to determine if it qualifies for the facility. The process varies for each client and depends on the transaction’s complexity, the assets to be financed, and their location. This process often includes an examination of your company’s finances, site visits to assess the value of assets, and other relevant evaluations.
b) Line usage
Line usage is typically priced using a “base rate + X%” model. The base rate references a published rate, such as the SOFR or the prime rate. The X% represents an “uplift” that is added to the base rate. The uplift accounts for the general risk of the line, its size, and market conditions.
Read “ABL Costs and Rates Explained” to learn more and see examples.
5. Lender considerations
The construction industry presents unique challenges for lenders. This is one of the reasons why only a few lenders specialize in this area.
a) Mechanic liens
Suppliers and subcontractors often file a lien in any construction project in which they are involved. These liens take priority over other liens and protect the provider if they don’t get paid.
Mechanic liens can create a problem for the lender, especially if the client uses subcontractors. Lenders often mitigate this risk by closely monitoring the payments of subcontractors and suppliers. Additionally, they may periodically review open liens.
b) Union actions
Some subcontractors have union employees. In such cases, your lender may require verification that all company dues have been paid and that there are no outstanding union disputes that could affect the company.
c) Bonding companies
Asset-based lenders require a first-position lien on the assets that secure the line. This may create a problem if your company needs to get a bond for a project. Bonding companies also require a first-position lien on the accounts receivable generated by the projects they bond.
6. Things to consider
At first glance, many construction companies may consider asset-based loans to be a near-ideal product. It offers most of the benefits of a bank facility but has fewer covenants and simpler qualification requirements.
In our experience, many smaller companies underestimate the effort required to deploy and manage an asset-based facility. This can lead to problems down the road.
a) Borrowing base certificate
The borrowing base certificate is a crucial component of an asset-based loan. The certificate requires information from your company’s accounting system. Companies that fail to maintain up-to-date accounting information will encounter difficulties generating the certificate. This may delay or prevent you from accessing your line.
b) Financial reporting
Your company must be able to provide the lender with updated financial statements and asset reports. This can be labor-intensive, especially if your company’s transaction is complex.
c) Covenants
Your company will have to comply with the ABL covenants to keep the facility in good standing. While ABL covenants are simpler than bank covenants, they still require careful management and attention.
d) Accounts receivable requirement
Most asset-based lenders will only finance your company’s fixed assets if you also finance your accounts receivable. Consequently, an ABL may not be the best option if you only need to finance a fixed asset.
e) Due diligence
Asset-based financing lenders typically perform extensive due diligence before approving and deploying a facility. The due diligence process can involve examining your financial records, conducting site visits, and evaluating your company’s assets.
The due diligence process can be intensive, especially in complex transactions (e.g., special assets). Your team should be prepared to invest the necessary time to help the lender understand your company and its objectives.
7. Alternatives
Construction subcontractors that can’t qualify for a conventional asset-based loan should consider using single-asset lines as an alternative. These lines can finance your accounts receivable, machinery, or equipment.
a) Construction factoring
Construction factoring allows construction subcontractors to finance their invoices. The line is similar to a revolving line of credit financed by accounts receivable, but it has additional controls. Construction factoring lines have simpler qualification criteria and can be deployed in a week or two. Read “How does construction factoring work?” to learn more.
b) Machinery/equipment financing
Companies that need to finance equipment or machinery can use a term loan from an equipment lender. These companies specialize in financing these assets, have simpler qualification requirements, and can deploy the line relatively quickly.
c) Working with multiple providers
One disadvantage of working with multiple finance companies is that you may deal with inter-creditor issues. This situation arises when a new lender needs to have a first position on an asset that an existing lender has already encumbered.
The most common situation is when lenders minimize their risk by placing a lien on all of a borrower’s assets, rather than just the specific asset being financed. This lien may prevent future lenders from working with you, as they won’t be able to obtain a first-position lien on the asset that secures their line.
The simplest way to handle this challenge is to read your contracts carefully and negotiate the collateral requirements before signing on. Getting a subordination after a contract is signed can be difficult. The finance company has little incentive to provide it.
Looking for asset-based financing?
Commercial Capital is a leading provider of asset-based financing to small middle-market companies. For more information, fill out this form or call us toll-free at (877) 300 3258.