Summary: A ledgered line of credit (LLOC) is a revolving financing facility secured by accounts receivable (A/R). The line’s availability is determined by the value of eligible receivables and the terms of the facility.
Ledgered lines of credit are more flexible, easier to use, and simpler to manage than comparable solutions. This article explains how ledgered lines of credit work, their advantages, qualification requirements, and how they compare with other financing options. We cover the following in detail:
- What is a ledgered line of credit?
- How does a ledgered line of credit work?
- Rates and pricing
- Advantages
- Qualification criteria
- Common business uses
- Comparison with other products
1. What is a ledgered line of credit?
A ledgered line of credit combines the receivables-based structure of invoice factoring with the revolving format of an asset-based loan (ABL). The line is secured by A/R but has simpler requirements and fewer covenants than a conventional ABL.
An LLOC allows a company to finance a percentage of its eligible accounts receivable, up to an established credit limit. The line’s availability adapts as new invoices are generated and existing invoices are paid.
Ledgered lines of credit are typically available in amounts ranging from $1 million to $25 million. However, the exact range varies by provider.
2. How does a ledgered line of credit work?
Using a ledgered line of credit is relatively simple. This section explains how line availability is determined, how funds are accessed, and how the outstanding balance is repaid.
a) Accessing funds
A company can access funds by submitting a draw request to the finance company. The draw request usually contains a list of invoices along with copies of the invoices.
Upon receipt, the finance company reviews your request, updates its ledger, and deposits the funds into your bank account.
b) Availability and credit limit
Each facility has a defined credit limit and an advance rate. The credit limit is the maximum amount a company can have outstanding under the line. The advance rate, also called the margin rate, is the percentage of eligible accounts receivable (A/R) that can be financed.
The typical advance rate is 85% of eligible accounts receivable and can go as high as 90% in some situations. Ultimately, the advance rate varies based on the client’s industry and needs, A/R quality, and other factors.
Example: A company with $2,000,000 in eligible receivables and an 85% advance rate would generate $1,700,000 in borrowing availability. If the facility has a $1,500,000 credit limit, the company can draw up to $1,500,000.
c) Minimum utilization
Ledgered lines of credit typically have a minimum utilization requirement. This means the company must maintain a minimum outstanding balance on the line. Most finance companies require clients to utilize at least 40% of the credit limit at any given time. However, the minimum varies by provider.
d) Determining eligible receivables
The line can be used only to finance eligible accounts receivable. Finance companies determine A/R eligibility by reviewing the credit quality of your customers and the age of your invoices. They also consider other criteria such as invoice dilution (e.g., discounts and allowances), your industry, and whether a large portion of your receivables is concentrated among a few customers.
e) Payments
Customers pay their invoices on their usual terms. Payments are directed to an account that can be accessed by the finance company for handling. Once a payment is received, the finance company applies the customer payment to the outstanding balance. This reduces the balance and increases borrowing availability.
3. Rates and pricing
Ledgered lines of credit are usually cheaper than comparably sized factoring lines and only slightly more expensive than comparable ABLs. They are priced using a reference rate, such as Canadian Prime or CORRA, plus an agreed-upon spread. For example, “Prime + X%,” where X% represents the spread.
The size of the spread (i.e., the X% ) depends on several factors. These include the size of the line, credit quality, receivables diversification, and general market conditions. In most cases, pricing ranges from Prime + 1% to Prime + 6%, depending on these factors.
Pricing is highly individualized and varies by lender. In general, larger lines backed by high quality accounts receivable have a lower spread than a smaller line with similar receivables quality.
Note: The pricing range is provided for illustrative purposes only and is subject to change.
a) How is the rate applied?
Most finance companies charge interest on the average net amount borrowed during the billing period. The average net amount borrowed accounts for advance requests and customer payments and reflects the line’s outstanding balance throughout the period.
4. Advantages
Ledgered lines of credit have several advantages over comparable solutions. Companies often prefer them because they are easier to use and have simpler compliance requirements. Key benefits include:
a) Fewer covenants
Ledgered lines have fewer covenants than bank lines, so compliance is simpler. This benefit is important if your company wants to finance accounts receivable only, since the line will be simpler to manage.
b) Access funds easily
Drawing funds from the line is relatively easy. As opposed to a conventional ABL, your company usually accesses funds by submitting a list of invoices. Some finance companies may also ask you to provide supporting documents for some invoices. Ledgered lines of credit generally do not require a detailed borrowing base certificate like an ABL. This makes them much easier to manage.
c) Simple qualification criteria
Ledgered lines of credit have simpler qualification criteria than asset-based loans and bank lines of credit. This simplicity makes ledgered lines attractive to growing small businesses that can’t meet the stringent requirements of a bank lender.
d) Scales with sales growth
Ledgered lines of credit are adaptive; availability increases as your company generates invoices while your outstanding balance decreases as payments are received. In most cases, the credit limit can be increased quickly as long as your receivables meet the eligibility criteria.
e) Supports challenging situations
Ledgered lines can support business turnarounds, provided the company has a viable plan and an experienced management team. The lines can also work well for companies that have been assigned to a lender’s Special Assets group due to a technical compliance issue, such as revenue seasonality. These companies often have strong receivables even if they no longer satisfy a conventional lender’s criteria.
5. Qualification criteria
Ledgered lines are intended for larger small businesses and middle-market companies. The main qualification requirements include:
a) Monthly sales of $1M+
Ledgered lines typically require a company to invoice at least $1,000,000 per month. The lines can work with companies that have seasonal revenues, provided their annual revenue averages at least $12 million.
b) Quality invoices
Your company’s accounts receivable are the primary collateral for the line. Consequently, your clients must have good commercial credit and pay their invoices within 30 to 70 days.
c) Accurate financial statements
The company’s accounting system must be well maintained and have up-to-date information. Your company’s finance department should be able to generate accurate financial statements.
d) Reliable financial controls
Your company should have reliable financial controls, including:
e) Unencumbered accounts receivable
Ledgered lines rely on A/R as the primary collateral for the transaction and require a first-priority security interest in the company’s A/R, usually registered under the applicable provincial PPSA. Consequently, your invoices cannot be encumbered by other financing (e.g., bank loans).
f) Strong operational track record
Your company should have an established operating history and a reliable track record. Finance companies also look for stable operations and the ability to manage growth effectively.
g) No major tax or legal issues
Your company must be free of major tax or legal issues. Companies with legal or tax problems should consider other alternatives, such as factoring.
6. Common business uses
The following examples show how companies can use a ledgered line of credit in different situations. They also show when an LLOC may be a better fit than a company’s existing financing.
a. Trucking company that outgrew factoring
A trucking carrier had been using its factoring line for a few years. The factoring line had helped the company grow from a carrier with a small fleet into a well-established midsized carrier. The company was well managed, had consistent revenue, and was growing at a steady rate.
The carrier was able to replace its existing factoring line with a ledgered line of credit that offered the same 90% advance rate, but with lower financing costs and simpler management. This gave the company a financing structure that was better suited to its size and stage of growth.
b. Staffing agency with fast-paced growth
Two partners used their savings to launch a staffing agency that grew faster than they expected. They encountered a common cash flow problem. Their clients paid their invoices in 30 to 60 days, but employees needed to be paid weekly.
They were able to handle this challenge, at least initially, with loans from associates and investors. However, the demands of their business soon outgrew their ability to finance through investor loans.
The company was well managed and organized and had shown consistent profitability. The partners evaluated factoring, a bank line of credit, and a ledgered line of credit. They chose the LLOC because it offered limits that could adapt easily to business growth. It also did not have the added oversight of factoring or the restrictive covenants associated with banks.
c. Manufacturing company assigned to special assets
A growing manufacturing company with seasonal revenue fell out of compliance with the covenants on its existing financing facility. Consequently, it was transferred to the lender’s special assets group.
The company remained profitable and continued to grow. It had no underlying structural problems. The issue was that the lender’s covenants were not well suited to the manufacturer’s seasonal revenue patterns.
The manufacturer replaced its existing facility with a ledgered line of credit. The new LLOC provided greater flexibility, and its lighter covenant structure was better suited to the manufacturer’s needs.
7. Comparison with other products
Ledgered lines of credit are typically used by companies that have outgrown their factoring line but aren’t ready for an asset-based loan. Consequently, LLOCs are usually compared with these two products.
a) Invoice factoring
Ledgered lines and invoice factoring offer similar benefits. However, ledgered lines are simpler to use, cheaper, more flexible, and have fewer controls than a comparable factoring line.
Accessing funds from a factoring line can be cumbersome. The client has to submit a schedule of accounts, invoice copies, and supporting documentation to the factoring company. Factoring companies then verify the invoices for accuracy before funds are deposited into the client’s account.
Ledgered lines, on the other hand, have a simpler process for accessing funds. The client typically submits a list of invoices and a funding request. The finance company relies primarily on the client’s financial controls to ensure invoices are properly issued and tracked. However, finance companies reserve the right to spot-check invoices to ensure accuracy.
Read “Ledgered line of credit vs. Invoice factoring” and “How to Move from Invoice Factoring to a Ledgered Line of Credit” to learn more.
b) Asset-based loans
Ledgered lines of credit provide many of the benefits of an asset-based line of credit secured by A/R. However, they have simpler qualification and compliance requirements than asset-based loans. Consequently, they are also easier to use and maintain.
Asset-based loans have stricter underwriting criteria since they can include several asset types. Furthermore, some lenders evaluate collateral using third parties to ensure it meets their requirements. This process can be expensive, more extensive, and time-consuming.
A company can access funds by submitting a borrowing base certificate. Generating the certificate usually requires your accounting to be updated and reconciled. This process can be burdensome, especially if a company is only financing A/R.
Ledgered lines of credit don’t typically require a borrowing base certificate. However, some companies may use them, and this varies by provider.
Asset-based loans also have stricter qualification requirements and more covenants. Consequently, managing the facility is more time-consuming.
Ledgered lines are slightly more expensive than an asset-based loan of comparable size. For most smaller companies, the benefits of a ledgered line typically outweigh this drawback.
Read “Ledgered line of credit vs. Asset-based loan” to learn more.
Looking for a ledgered line of credit?
We are a leading provider of ledgered lines of credit, asset-based financing, and invoice factoring. For more information, fill out this form or call us toll-free at (877) 300 3258 to speak with a representative.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.