Can ABL options fuel your business growth?

Looking to secure capital without relying on the cash flow of your organization? Asset-based lending (ABL) has evolved into a tried-and-true solution for companies with strong working capital assets.

No longer considered “the loan of last resort,” an asset-based loan might be a key element to fund your expansion.

“Most commercial loan Borrowers leverage cash flow revolvers, so they’re focused primarily on the borrower’s financial performance in terms of how they structure their loans,” says John Freeman, Head of Sales and Originations of Asset Based Finance at U.S. Bank.

“Conversely, on the ABL side, we’re looking at the company’s balance sheet, the assets that it owns and what those assets generate in terms of their collateral value. These values are used to formulate the client’s borrowing base and are the basis for determining the client’s maximum debt capacity under an ABL contract.”

Cash-flow lending versus ABL

In traditional cash-flow-based lending, a borrower's financial performance is king. The amount of money you can get for a commercial loan is usually dependent upon earnings before interest, taxes, depreciation and amortization (EBITDA). Basically, the more cash your business generates, the more money you can borrow.

ABL, on the other hand, considers assets. Lenders in the ABL business typically advance funds based on a percentage of secured asset value — generally 85-90% of eligible receivables, for instance, and 50-75% of eligible inventory.

Businesses with thin or volatile EBITDA margins can turn to asset-based loans to fuel growth or improve cash flow. In exchange for the willingness of a bank to loan on assets, ABL borrowers typically have monthly collateral reporting requirements.

Interest rates on ABLs are comparable to those of traditional commercial loans. This reflects the value the lender places on the fully secured nature of the ABL.

The difference a recession makes

Despite the obvious appeal of predictable debt capacity and financial flexibility, ABL facilities haven’t always been viewed as favorable as they are today, according to Freeman. “Decades ago, an asset-based loan was viewed by many Borrowers and their advisors as a lender solution, not a borrower solution,” he says. “It was a loan that some viewed as a last resort to stave off a financial restructuring.”

Attitudes toward ABL have broadly changed over the last couple of decades. As requirements for conventional commercial loans tighten, borrowers need alternative ways to finance growth and sustain operations. Banks respond with ABL products, offering newer and more favorable terms, such as fewer financial covenants. The ABL business has grown in popularity ever since.  “An ABL facility allows the Borrower’s CFO and Treasurer to sleep better at night knowing exactly how much liquidity they will have access to in the morning and knowing that they will no wake up in a default situation because they’re experiencing cyclical or seasonal financial performance volatility”, Freeman says.

To determine whether it can benefit from commercial asset-based loans, your organization should ask itself two primary questions, according to Freeman:

1. Does leveraging your assets provide greater borrowing capacity than leveraging your cash flow?

If your organization invests heavily in physical materials or merchandise, it might be a suitable candidate for an asset-based loan. Even if your organization has strong liquidity, when leveraging your asset values outstrips leveraging your cash flow, ABL can improve your borrowing position.

“Say a company’s EBITDA is $15 million,” Freeman says. “The typical bank will lend three times that. But if that same company has lendable working-capital assets that generate a borrowing base of $75 million, then all of a sudden, an asset-based loan will be more attractive based simply on debt capacity.”

Industries well positioned to tap into ABL funds can include retailers, distribution companies, food and beverage firms and manufacturers, as well as commodities-based companies in sectors such as building products, metals and mining, or oil and gas. “A key consideration is the strength and volatility of a company’s operating margins,” Freeman says.

2. Do you need financial flexibility?

Organizations experiencing periodic market volatility and variability are good candidates for ABL, because they may need greater financial flexibility.

“Companies that borrow on a cash-flow basis typically have several, if not many, financial covenants requiring them to perform at a certain level,” Freeman says.

For instance, conventional financing typically requires that borrowers maintain a minimum level of operating performance to retain a revolving line of credit.

On the other hand, lenders that provide ABL typically focus on borrower liquidity, which allows them to provide far greater financial flexibility. Retailers and commodities-based companies are ideal examples. The former experience large seasonal shifts in income, while the latter is often subject to economic upswings and downturns that dramatically affect earnings.

Does your business have collateral that lenders are looking for?

Not all collateral is equally suited to an ABL; lenders prefer collateral that is liquid. As a result, they look for assets in the order of preference listed below. This list can help you determine if your collateral will be attractive to lenders when you consider an ABL for your company:

1. Receivables
2. Inventory
3. Equipment
4. Real estate

The higher assets in that ranking are more liquid, and as a rule of thumb, the faster an asset turns, the more attractive it is to lenders.

In contrast, the following types of collateral tend to be less desirable when securing commercial asset-based loans:

• Receivables that are past due or subject to high dilution levels
• Receivables that include progress billings
• Foreign receivables without insurance or not backed by a letter of credit
• Inventory that is slow-moving, specialized or consigned
• Single purpose real estate or equipment that can be difficult to monetize. For example, large facilities, such as a steel mill or foundry, are challenging as collateral, but multipurpose buildings like warehouses near dense city centers are not.
  

Learn more about which assets are eligible as collateral in an asset-based loan.
 

Embrace opportunities using ABL funds

Often, asset-based lending can come through in times of opportunity. Freeman tells of a client, a family-owned manufacturer of consumer product goods, that had a “once-in-a-lifetime opportunity” to buy a regional competitor that was seeking to sell due to succession planning reasons. Freeman says the company used ABL to leverage not only its own working capital but also the debt capacity of the assets it was buying.

“By utilizing an ABL revolver, they were able to afford this very large acquisition,” Freeman says. “At the end of the day it’s about maximizing liquidity and covenant flexibility.”

Asset-based lending has become more popular than ever. Contact U.S. Bank to learn more about whether ABL is the right financing option for your organization.