Summary: Asset-based loans are an attractive option for middle-market companies due to their flexibility and relatively low cost. However, they are suitable only for companies with good financial management due to their strong covenants and operational requirements. This article examines stand-alone asset-based financing solutions that can be used as an alternative to asset-based loans.
These solutions have simpler qualification requirements and covenants, making them attractive to smaller companies. We cover the following subjects:
- What is an asset-based loan?
- Limitations of asset-based loans
- Single vs. multiple lenders
- Finance accounts receivable
- Finance inventory
- Finance equipment and machinery
- Working with multiple providers
1. What is an asset-based loan?
An asset-based loan (ABL) is a comprehensive financing solution that allows companies to finance different types of assets. They are popular with lower-market and middle-market companies that need financing.
Lines that are secured by current assets, such as accounts receivable and inventory, are typically structured as revolving lines. Your company can withdraw funds at any time up to a credit limit. The line’s limit is determined by the value of your accounts receivable and/or inventory.
Lines that are secured by fixed assets, such as machinery and equipment, are offered as term loans. Your company receives an amount based on the asset appraisal, which is repaid in installments over a specified period.
Companies that finance multiple asset types typically get a separate line for each asset type. Read “What is an asset-based loan? How does it work?” to learn more.
2. Asset-based loan limitations
Asset-based loans have more complex qualification requirements than other solutions. They can also have extensive covenants and require ongoing maintenance. Business owners and managers should take these issues into consideration before getting a loan.
a) Accounts receivable requirement
Most conventional asset-based lenders will only finance your fixed assets if you also finance your accounts receivable. Consequently, they are better suited for some types of companies.
This is a serious limitation for companies that only want to finance fixed assets or work in certain industries. Note that there are some asset based lenders that will finance only fixed assets.
b) Qualification requirements
Asset-based loan qualification requirements are more complex than similar options, except for bank financing. These include minimum revenues, a suitable asset mix, and ongoing financial reporting, among others. Consequently, these facilities are better suited for midsize companies.
c) Strict covenants
Asset-based loans have stricter covenants than most solutions, except bank financing. Consequently, you will need to track company metrics regularly to ensure you remain in compliance. Companies that don’t have good financial controls may be better served by an alternative solution.
d) Overall maintenance
Asset-based loans require more maintenance than comparable alternatives. Maintenance requirements vary by line complexity and lender. However, most lenders follow similar approaches.
Lines require ongoing financial reporting to keep up with covenants requirements. Additionally, lenders regularly monitor the quality and value of assets. This may require specialized reporting and/or field exams.
Additionally, your company may have insurance requirements, legal monitoring, and other relevant considerations. All of these activities add to your team’s workload.
e) Operation
Asset-based loans operate with a borrowing base certificate. This document is used to manage the line’s availability. Borrowing base certificates require that you have up-to-date information about the state of your A/R, inventory, and line balance. Consequently, your accounting and inventory systems must be updated regularly.
Updating a borrowing base certificate can be nearly impossible unless your financial systems are updated regularly. Companies without established finance departments should consider alternative financing solutions. Read “What is a borrowing base certificate?” to learn more.
3. Single vs. multiple lenders
One clear advantage of working with an asset-based lender is that you work with a single provider. That can be an advantage in many circumstances, especially for middle-market companies. However, this has the limitations we covered in the previous section.
The alternative is to work with providers that specialize in financing a single asset. This can work well if your company is small or if you only want to finance a single asset, such as accounts receivables.
Single asset specialists usually have simpler qualification terms and faster deployment times. Working with specialist providers is well-suited for smaller companies or those that cannot qualify for an asset-based loan. However, working with multiple providers also has limitations. We cover this issue in the final section.
4. Finance accounts receivable
Many companies use asset-based loans specifically to finance their accounts receivable. They work with clients that pay invoices within 30 to 90 days, which affects their liquidity. Two alternatives can work well if you only need to finance your invoices, ledgered lines of credit and invoice financing.
a) Ledgered line of credit
A ledgered line of credit, also known as sales ledger financing, operates similarly to a revolving line of credit, secured by accounts receivable. The finance company provides availability based on the value and quality of your accounts receivable.
Lines have simpler qualification requirements and covenants than comparably sized asset-based loans. They are also simpler to operate. Ledgered lines of credit do not require a borrowing base certificate, and drawing funds requires a simple report. Read “What is a ledgered line of credit?” to learn more.
b) Invoice factoring
An invoice factoring line also provides a revolving facility secured by your company’s accounts receivable. This solution is intended for companies that don’t meet the requirements for a ledgered line of credit.
Factoring lines have the simplest qualification requirements fewest covenants, and can be deployed within days. However, the solution has more direct lender controls than alternatives. Read “What is factoring? How does it work?” to learn more.
5. Leverage inventory
An inventory financing line enables you to leverage the inventory your company owns and has already paid for. In our experience, companies often find inventory financing lines to be expensive and difficult to manage.
These lines typically require a perpetual inventory system and ongoing field exams. Furthermore, they are expensive and often allow you to leverage up to 70% of the Net orderly Liquidation value.
We suggest considering inventory financing only if you have attempted to leverage your accounts receivable and it does not provide sufficient cash flow. Read “How does inventory financing work?” to learn more.
6. Leverage machinery and other fixed assets
Companies with fixed assets, such as machinery, can often use a specialized lender to finance the assets. These lenders can issue a term loan based on the appraised value of the asset. These lines have simple qualification requirements and often work well for companies that only need to finance a high-quality fixed asset.
7. Working with multiple lenders
One of the advantages of using an asset-based loan is that a single provider handles everything. Consequently, you don’t have to worry about potential inter-creditor issues. On the other hand, inter-credit issues can surface if you have multiple stand-alone facilities.
All lenders file a lien against the assets that secure their facility. However, lenders often secure their position with an ‘all assets’ lien to reduce their risk. This increases their collateral position and reduces their risk.
This brings up a potential limitation of working with a specialty lender. Specialty lenders often finance a single asset type, such as accounts receivable (A/R) or machinery. Companies that need to finance multiple asset types often need to use multiple lenders. This can lead to collateral problems.
a) A common problem
Consider a scenario where a company finances its accounts receivable and the lender secures their position against all assets. At a later time, the company decides to finance its machinery. However, the new lender won’t be able to secure a first-position lien against your machinery. The A/R lender already holds that position.
Now you have a challenge. You must convince the A/R lender that they are over-collateralized and to provide a subordination for the machinery component. This situation leaves you at a clear disadvantage.
b) The solution
The solution to this problem is simple, though not always easy. Negotiate with the lender to ensure they only secure their position with the relevant assets. Remember that once the contract is signed, the lender has little incentive to change their position.