It’s time to take a fresh look at asset-based lending
So before lending, asset-based lenders will usually have machinery or equipment independently valued by an appraiser. For inventory-backed loans, they typically require regular reports on inventory levels, along with liquidation valuations of the raw and finished inventory. And for loans backed by accounts receivable, they usually perform detailed analyses of the eligibility of the collateral based on past due, concentrations and quality of the debtor base. But unlike banks, they usually do not place tenuous financial covenants on loans (e.g., a maximum debt-to-EBITDA ratio).
ABL: The Nuts and Bolts
Asset-based lending is actually an umbrella term that encompasses several different types of loans that are secured by the assets of the borrower. The two primary types of asset-based loans are factoring and accounts receivable (A/R) financing.
Factoring is the outright purchase of a business’ outstanding accounts receivable by a commercial finance company (or factor). Typically, the factor will advance the business between 70 and 90 percent of the value of the receivable at the time of purchase; the balance, less the factoring fee, is released when the invoice is collected. The factoring fee typically ranges from 1.5-3.0 percent, depending on such factors as the collection risk and how many days the funds are in use.
Under a factoring contract, the business can usually pick and choose which invoices to sell to the factor. Once it purchases an invoice, the factor manages the receivable until it is paid. “The factor will essentially become the business’ defacto credit manager and A/R department,” Klausen notes, “performing credit checks, analyzing credit reports, and mailing and documenting invoices and payments.”
A/R financing, meanwhile, is more like a traditional bank loan, but with some key differences. While bank loans may be secured by different kinds of collateral including equipment, real estate and/or the personal assets of the business owner, A/R financing is backed strictly by a pledge of the business’ outstanding accounts receivable.
Under an A/R financing arrangement, a borrowing base is established at each draw, against which the business can borrow. A collateral management fee is charged against the outstanding amount, and when funds are advanced, interest is assessed only on the amount of money actually borrowed.
According to Klausen, an invoice typically must be less than 90 days old in order to count toward the borrowing base. There are often other eligibility covenants such as cross-aged, concentration limits on any one customer, and government or international customers, depending on the lender. In some cases, the underlying business (i.e., the end customer) must be deemed creditworthy by the finance company if this customer makes up a majority of the collateral.