An asset-based loan (ABL) is a type of business financing secured by company assets. ABLs allow companies to borrow from assets to cover expenses or investments as needed. In this article, we cover:
- What is an asset-based loan?
- How do ABLs work?
- Who qualifies for asset-based lending?
- What is a borrowing base?
- How does due diligence work?
- How much do asset-based loans cost?
- Alternative solutions
1. What is an asset-based loan?
An asset-based loan is a type of financing that allows companies to leverage some of their existing assets. These loans provide companies with funds to pay for new investments or cover ongoing expenses. ABLs are often used by small companies that aren’t ready to qualify for bank financing or find banking covenants too burdensome.
2. How do ABLs work?
Asset-based loans can be implemented as conventional term loans, revolving lines of credit, or a facility that has both options operating at the same time. The loan structure usually depends on the underlying assets that serve as collateral for the loan.
a) Transactions secured by tangible assets
ABLs secured by machinery, equipment, or corporate real estate are usually structured as conventional term loans. In these transactions, the lender lets the client borrow a percentage of the asset’s appraised value. The percentage that is offered depends on the type of assets that are used as collateral. The loan is amortized and paid over a number of years.
b) Transactions secure by accounts receivable
Transactions secured by receivables or inventory are usually structured as revolving lines of credit. These lines allow clients to draw funds on a percentage of their accounts receivable up to a certain limit. The percentage and credit limit are determined by your needs, volume, industry, and risk. The lines are paid back as your clients pay their invoices on their usual terms.
Clients draw funds from the line using a borrowing certificate. The borrowing certificate is a document (e.g., a spreadsheet) that enables the client to calculate the borrowing base by entering some financial information. Most lenders allow clients to borrow up to 85% of their eligible accounts receivable, though that amount varies by transaction.
3. Who qualifies for asset based lending?
Asset based loans are offered to stable small and mid-sized companies that have assets that can be financed. The company’s assets must not be pledged as collateral to another lender since the ABL finance company needs first collateral position. If the assets are pledged to another lender, the other lender must agree to subordinate its position on the specific assets. Lastly, the company must not have severe accounting, legal, or tax issues that could create encumbrances.
Most asset-based loans have a minimum utilization requirement of $750,000/month. Companies that don’t meet this requirement should consider a different solution, such as sales ledger financing. We provide details on potential alternatives in section 7.
4. What assets can be used as collateral?
Companies can leverage most of their conventional marketable assets as long as the value can be appraised easily. Common assets include:
- Accounts receivable
- Inventory
- Machinery
- Equipment
- Real estate (e.g., company’s office or plant)
Each provider has its own set of competencies and preferences. Many companies prefer accounts receivable due to their quick turnaround and ease of appraisal. However, some companies are comfortable financing a mix of assets.
5. How does the due diligence process work?
The due diligence process enables the lender to determine the opportunity’s viability and the terms to offer. The process varies based on the transaction’s size, industry, and complexity. During due diligence, the lender reviews your company’s financial records and appraises the company’s assets. This process usually requires site visits, and lenders often send appraisers to evaluate collateral at its location. Note that clients must cover the due diligence cost, which varies by company and transaction.
6. What is the cost of an ABL?
Most asset-based loans have two costs, the due diligence to underwrite the transaction and the cost of using the ABL.
a) Due diligence cost
The due diligence cost covers all the expenses associated with underwriting the asset-based loan. There is no set cost per se since it varies based on the specific details of the transaction. Larger and more complex transactions are more expensive to underwrite than smaller, straightforward ones. Due diligence costs cover expenses such as:
- Site visits
- Financial reviews
- Asset appraisals
- Legal expenses
b) Financing cost
Most financing costs are based on the prime rate and use a “prime plus X%” model. Most term loans against machinery or equipment use an annual percentage rate (APR). Lines of credit secured by accounts receivable or inventory usually charge a rate based on utilization. Some lenders also have additional fees to cover maintenance and management.
7. Other options
Companies that want to finance only their accounts receivable but don’t qualify for an ABL can consider the following two options.
a) Sales ledger financing
Sales ledger financing works much like an ABL line of credit secured by accounts receivable. However, they have simpler qualification requirements and are easier to operate. Lines can start at a minimum utilization of $250,000 and don’t need a borrowing certificate to draw funds. Instead, the company can simply present the list of the invoices they want to finance. Ledgered lines of credit, as these lines are often called, are slightly more expensive than an ABL of comparable size but are much simpler to operate. This advantage makes sales ledger financing a great alternative for small companies that cannot qualify for a conventional ABL.
b) Accounts receivable factoring
Companies that cannot qualify for sales ledger financing should consider using accounts receivable factoring. Factoring allows companies to finance their invoices, much like sales ledger financing. However, this alternative has simple qualification criteria and minimal covenants. Lines are also very flexible, and companies can quickly increase credit limits. Furthermore, factoring can be used by companies that have some problems and are in the midst of a turnaround.
There are some differences between factoring and ABLs that managers should keep in mind. In general, factoring companies need additional documentation and controls during funding since the transaction works by selling your invoices to the factor. Also, factoring lines are more expensive than comparable sales ledger financing lines. To learn more, read “What is Accounts Receivable Factoring?”
Need asset based financing?
Commercial Capital LLC is a leading provider of asset based financing. For more information, get an instant quote or call us toll-free at (877) 300 3258.