ABL…? Airborne Lasers? Advanced Blending? Abetalipoproteinemia? No, in this case … Asset Based Lending.
If your business has high inventory levels or is poised for rapid growth, but lacks cash flow, an asset-based loan (ABL) might be the perfect fit. Despite greater leverage tolerance and higher advance rates, ABL pricing is only modestly more expensive than traditional loans, because it has a proven track record in minimizing lender losses. And is cheaper than factoring.
Does your organization have accounts receivable and inventory that can be leveraged to improve liquidity? The nature and quality of your working capital can make all the difference.
Companies that maintain high levels of quality working capital assets and produce modest cash flow are ideal candidates for an asset-based loan (ABL).
Liquid Collateral is Key for Leveraging an Asset-based Loan
Large retailers, manufacturers and distribution companies are good candidates for ABLs as they invest significantly in working capital and often produce relatively low free cash flow (FCF).
An ABL can be perfect for a company of this profile, particularly if they are poised for rapid growth, acquisitions or considering a shareholder buyout. Many companies can generate higher debt capacity via a borrowing base, rather than traditional commercial loans.
The traditional way to measure debt capacity is a function of cash flow, typically calculated as a multiple of earnings. ABL uses a borrowing base predicated on working capital liquidation values, which typically range from 40 percent to 70 percent for inventory and 80 percent to 90 percent for accounts.
Eligible Collateral Has a Hierarchy
Lenders specializing in asset-based loans look for collateral that’s liquid. The stack-rank asset preference is typically:
4. Real estate
The higher an asset is in the ranking, the more liquid it is. Ideal collateral are accounts receivable or inventory that’s easily valued and monetized. Generally, the faster that the asset turns, the more attractive it is as collateral.
It’s Important to Prepare for a Meeting with Prospective Lenders
Lenders often start the process of evaluating their working capital assets: inventory, machinery and equipment, and/ or real estate. After funding, the lender tracks adjustments in value through frequent reporting, periodic exams and inventory appraisals during the lending period. As a borrower, you will be asked to submit reports at least monthly, that reflect changes in the quantity and/or value of your working capital assets. Your CFO plays a critical, ongoing role as the point person with your lender.
ABL Pricing Can be Competitive with Traditional Loans
Costs can vary by lender, but most borrowers can expect to pay loan costs – such as a closing fee, a direct interest charge, unused fees and modest monitoring fees. Despite greater leverage tolerance and higher advance rates, ABL pricing is only modestly more expensive than traditional loans, because it has a proven track record in minimizing lender losses. And is cheaper than factoring.
Michael Stier is an Area President for FocusCFO based in Charlotte, NC.