This issue’s question

“What do corporates need to know about asset based lending and why might the solution work for them?”

Edward Sunderland

Partner

Pinsent Masons

Asset based lending (ABL), was previously viewed as a last resort for troubled businesses needing a quick cash injection. The last few years have seen this perception change with ABL now growing in popularity, and being used more and more by healthy and successful businesses looking to secure lending against its “borrowing base” rather than on a cash flow basis.

A business’ borrowing base can be very broad, which opens up opportunities for businesses to secure lending across a large scope of assets. The assets included in a borrowing base are deal specific, but lenders usually include some or all of working capital (accounts receivable and inventory), machinery and equipment, property and other intangible assets. The broad range of assets that can be incorporated means that there are various forms of ABL, with the type of facility being tailored to fit the needs of each particular business. Typically, funding is made against receivables and inventory, and thus ABL is seen very much as a working capital solution.

Invoice discounting is the most common form of ABL in use and involves the funder acquiring, at discount, a business’ receivables. It can be implemented on either a confidential (so the end debtor does not get notified) or disclosed (where the end debtor is) basis. Confidential invoice discounting is invisible to the customer with the business still managing its client relationships. Alternatively, the business could be happy to outsource all the debt collection to the funder as well – with this solution more commonly known as factoring. This approach is more typically focussed on SMEs, who don’t have the resources to run significant finance collection teams.

As well as addressing working capital, ABL can assist businesses in acquisitive behaviour, refinancing and restructuring or simply as a “safe” method of lending more. For a bank lender, the asset-backed nature of the lend makes it, absent fraud, less likely to produce a loss upon default; this leads to a lower internal capital cost and, accordingly, more attractive pricing to a corporate. The potential downside to a corporate is that there is more administration in running such a facility. However, having suitable controls and monitoring over the working capital and assets is never a bad thing, and a number of corporates have subsequently commented that their internal financial visibility has increased. The documentation required when setting up an invoice discounting facility is quite simple, as there are bank standard forms which can be signed very quickly. However, where there is a more bespoke ABL solution being put in place, the documentation process can be quite long and intensive.

How does it work? The ABL funder applies a static advance rate against a class of assets (ranging from 50% on inventory, to 90% against receivables). This provides a flexible credit line that expands and contracts in line with a business’ borrowing base, and is particularly suited to asset-rich businesses that are also growing, cyclical, seasonal, volatile and/or low margin. A huge draw to ABL is its ability to close the funding gap between a business issuing an invoice and being paid. After the business issues a client invoice, the funder will advance the business a percentage of the invoice value. This provides the business with an immediate injection of capital, instead of the business encountering a gap between issuing and payment.

Undoubtedly asset-based lending (ABL) has evolved into a more widely used debt product. In the UK, for instance, more companies are turning to ABL to support their working capital needs and overall growth, whether organic or through acquisition.

In fact, the Asset-based Finance Association (ABFA) reported earlier this year that the amount of asset-based financing secured by UK businesses against stock increased 22% from 2014 to 2015, with an uptick in the number of large businesses taking advantage of ABL.

From a sector perspective, at Wells Fargo Capital Finance we continue to see strong interest in ABL within retail, distribution, equipment rental, and manufacturing. We’ve also found opportunities to deliver flexible senior secured funding options to businesses in less traditional sectors, such as professional services and technology. Additionally, we’ve had great success working with private equity firms to support their acquisitions and the ongoing working capital needs of their portfolio companies.

However, despite a steady rise in the use of ABL, there still remains some lack of awareness and a historic reputation as lender of last resort.

Furthermore, while ABL has traditionally been viewed as an alternative to traditional financing, many companies that would qualify for traditional bank financing may prefer ABL based on a number of factors:

• Flexibility.
• Improved liquidity.
• Strong relationship.
• Creditworthiness.
• Structure.
• Syndication.
• Complementary.
• Price.
• Speed of decision.
• Covenants.

Whether the future business requirement is short-term working capital funding or acquisition debt to support long-term growth, ABL is a viable and flexible option that can help companies of varying sizes.

ABL is therefore a funding solution that is often overlooked by businesses due to dated negative connotations, when it can in fact provide flexible financing more suited to the needs of a business than that of a cash flow based facility.

Asset based lending (ABL) is a bespoke and flexible funding solution which allows a borrower to release fully secured debt funding against a variety of assets in its balance sheet. Typically, an ABL facility will comprise of revolving credit facilities secured against a borrower’s eligible receivables and inventory, together with repaying term loan facilities provided against property and plant and machinery.

Given the fully asset-secured nature of the facilities, lenders are often able to maximise a borrower’s debt capacity beyond other forms of debt structures, and allow for greater degrees of leverage, all at reduced lending margins.

Mainstream ABL lenders are able to enhance the core ABL debt structure with additional trade and ancillary facilities, thus providing end-to-end working capital solutions with associated interest rate and currency hedging instruments in support.

Asset-based lending can be a much-needed source of capital for companies that face a range of needs including:

• Growth.
• Refinancing.
• Restructure.
• Mergers and acquisitions.
• Management buyouts.

ABL protects equity in the business by leveraging assets more effectively, allowing firms to raise significant funds without sacrificing equity. It offers a lot of flexibility as it can increase or decrease with changes in the funding base and can be useful for businesses that face seasonal peaks or industry cycles where other sources of funding may be too inflexible to meet spikes in working capital.

It can be used as part of a wider funding package to improve working capital and support growth plans and is also popular because it can offer lower funding costs than traditional funding methods, whilst releasing significantly more capital.

There are very few downsides. ABL borrowers are likely to be required to provide more comprehensive management information to lenders in order to evidence the collateral securing the facility. However, this tends to become largely routine for ABL borrowers and, given the lender’s focus on the performance of working capital assets, these reporting obligations can frequently represent an opportunity for borrowers to understand the shortcomings and opportunities in better-managing their working capital cycle.

ABL is therefore an extremely effective tool which unlocks the capital tied up in a business’ balance sheet and is a product that helps support its working capital. It is best suited to businesses that have asset-heavy balance sheets and is typically popular amongst businesses involved in the manufacturing, services, wholesale and distribution sectors. It can accommodate any level of debt requirement, with facilities provided to relatively modest SMEs through to larger, more complex structures including syndicated, multi-national, multi-currency and multi-asset facilities.

Today, it is being used by businesses to support a range of circumstances in order to support their business ambitions. Used alongside other working capital products, including trade, receivables, purchase and asset finance, ABL can open the door to new opportunities for businesses and help them prosper.