Asset Based Loans
Asset Based Loans are loan secured by a company's accounts receivable, inventory, equipment, and real estate, whereby the asset-based lender takes a first priority security interest in those assets financed. It is an alternative to traditional bank lending because asset-based lenders target borrowers with risk characteristics typically outside a bank's comfort level.
Expert in all facets of collateralized lending, asset-based lenders possess the experience and know-how to structure the proper financing program for their borrowers. They specialize in financing businesses and business transactions involving a broad range of products and services.
Acceptable Collateral Types Asset based loans are made based the market value of a company's collateral. They focus first on the collateral's cash conversion cycle for repayment and on cash flow second. Asset-based lenders loan money to companies using two main types of credit facilities: . • Working capital facilities based on accounts receivable and/or inventory: Loans which finance accounts receivable and inventory are typically structured under a revolving line of credit or "revolver," without a scheduled repayment. The lender advances funds against the revolver to carry accounts receivable and inventory and, when such assets convert to cash, the advances are repaid accordingly. . • Fixed asset facilities to finance equipment and owner-occupied real estate: Loans financing equipment and real estate typically take the form of term facilities with a scheduled repayment usually equal to the fixed assets' useful life.
When do asset based loans make sense?.
Good candidates for an asset based loans have tangible or financeable assets that can be used as collateral, such as accounts receivable, inventory, equipment and real estate. These companies may have high leverage ratios, as measured by debt to equity, typically over 5 to 1, or may be marginally profitable companies, companies with a recent history of losses, or with inconsistent cash flow. .
But since the asset-based lender focuses on collateral, the borrower's eligibility for loan qualification is determined from an evaluation of the quality, liquidity, and sufficiency of the borrower's eligible assets. The lender analyzes each asset class to determine its net realizable value in a liquidation situation. It then uses this information to exclude certain assets from financing and set maximum advance rates. .
If the advance rate established by your lender creates adequate liquidity, asset based lending may be an appropriate solution to your company’s current financial requirements. .
Acceptable Uses of Funds.
Asset based loans provide capital for a wide variety of financial requirements including: . • Leveraged mergers and acquisitions • Turnaround/restructuring situations • Liquidity events for family-held businesses • Growth opportunities • Capital expenditures • Tight working capital • Seasonal or cyclical companies • Specialized industries • Stock repurchase • Public ownership to private ownership • Debtor-in-possession (DIP)/confirmation financing
Asset-Based Lending vs. Traditional Bank Financing
The primary difference between commercial banks and asset-based lenders is where they each look first for repayment: The bank looks to cash flow for repayment first, then collateral; while the asset-based lender looks to collateral first. Since banks underwrite cash flow as their primary repayment source, they typically require less collateral controls and monitoring but more financial covenants. For companies that are "asset heavy," an asset-based credit facility may be able to make more funds available because the loan is not based strictly on the anticipated levels of cash flow. Additionally, the structure often requires fewer covenants, thereby providing more flexibility for many borrowers.
How does the asset-based lender monitor its borrowers?
The level of controls and monitoring by the asset-based lender is directly related to the credit-worthiness of the borrower. Typical controls include: • A borrowing base formula that monitors the relationship between the value of the collateral available to secure the outstanding loan and the actual balance of the loan on a regular basis. • Funding controls (collateral monitoring) that may be administered daily, weekly, or monthly and range from submission of sales invoices/shipping documents to accounts receivable aging and listings/inventory listings. The degree of reporting depends on the borrower's risk rating. • Collection controls: The asset-based lender requires dominion (control) over cash by establishing a collateral account into which accounts receivable collections are deposited. Access to this account is restricted to the asset-based lender. Ongoing audits are also used to monitor the account. The asset-based lender will audit the borrower's books and records periodically to test the records' accuracy and validity and to substantiate collateral values as represented by the borrower.
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