ABL mythbusters: The truth about asset-based lending

For companies with meaningful accounts receivable, inventory or other financeable assets, asset-based lending (ABL) may provide greater borrowing capacity and flexibility than a traditional cash flow loan. Yet many business leaders continue to view ABL through the lens of outdated perceptions formed decades ago.

While ABL was once commonly associated with distressed borrowers, today it is used by middle-market companies, large corporations and private equity sponsors to support growth, acquisitions, recapitalizations, working capital needs and strategic transitions.

“At the end of the day, banks and other ABL lenders are looking to provide borrowers with incremental liquidity that can be used for organic growth, acquisitions, dividend recapitalizations and turnaround strategies,” says John Freeman, Head of Asset-Based Finance, U.S. Bank. “The product provides meaningful flexibility to borrowers.”

Before dismissing ABL as a financing option, it is worth separating fact from fiction.

Four common myths about asset-based lending

Myth 1: Asset-based loans are only for distressed companies

Reality:  ABL has evolved into a mainstream financing solution used by healthy businesses across a wide range of industries. For companies with significant working capital assets, an asset-based structure may provide more liquidity than a facility sized primarily on earnings.

Why it matters: A company does not need to be experiencing financial stress to benefit from ABL. Many borrowers use it proactively to support growth, acquisitions and shareholder objectives.  

“For an asset-heavy company with thin margins and lower EBITDA, an ABL can be a better fit than a cash flow structure,” Freeman explains. “It depends on the makeup of the company and the quality of its assets.”

Myth 2: Private equity sponsors do not like ABL

Reality: Many private equity firms incorporate ABL into acquisition and portfolio company financing strategies. Because ABL is driven by collateral values rather than only EBITDA multiples, it can provide an efficient source of senior capital.

Why it matters: ABL may reduce reliance on more expensive forms of debt while increasing the liquidity available to support a transaction.

“ABL sizing is not driven by the same multiple of EBITDA,” Freeman says, “so it may provide more of the total liquidity solution at a lower cost than higher-priced junior debt.”

Myth 3: ABL is more expensive than traditional lending

Reality: ABL facilities can be priced competitively with other senior financing alternatives. Pricing depends on collateral quality, transaction structure, market conditions and the overall banking relationship.

Why it matters: Companies should evaluate alternatives based on total liquidity, covenant flexibility and overall economics rather than outdated assumptions about cost.

Myth 4: Asset-based loans require excessive reporting

Reality: Modern enterprise resource planning systems and automated reporting tools have reduced the administrative burden associated with collateral reporting. Many borrowers can use existing financial systems to satisfy reporting requirements efficiently.

Why it matters: Reporting should be viewed as a practical trade-off for increased borrowing capacity and flexibility, rather than a barrier to considering ABL.

“Modern ERP systems allow today’s ABL borrowers to easily generate and submit period reporting requirements,” says Freeman. “Gone are the days of cumbersome ABL reporting in which companies needed to add dedicated treasury staff to comply with the reporting requirements.”

Read more: When is ABL right for your business?

Read more: Collateral options for ABL: What's eligible, what's not?

>> Learn more: Contact us to discuss how asset-based lending can fuel your growth strategy.

How asset-based lending works

Traditional revolving credit facilities are typically sized using cash flow metrics such as earnings before interest, taxes, depreciation and amortization, or EBITDA. In asset-based lending, banks take a different approach. Borrowing availability is primarily determined by the value of eligible assets, such as accounts receivable and inventory, that serve as collateral for the loan.

Because of this structure, companies with substantial working capital assets may be able to access greater liquidity than they could through a traditional cash flow facility. As assets grow, borrowing availability can increase as well, creating a financing structure that aligns with many businesses' operating cycles.

At its core, ABL helps businesses unlock liquidity from assets already on their balance sheet and deploy that capital to support strategic objectives.

When ABL may be a good fit

Growth of transaction activity

• The company is pursuing rapid growth, an acquisition, a recapitalization or another strategic transaction.
• Seasonal working capital needs fluctuate materially during the year.

Balance sheet strength

• The company has meaningful accounts receivable and inventory.
• Asset values may support greater borrowing capacity than cash flow alone.
• Margins are relatively thin, but working capital assets are substantial.

Need for flexibility

• Management wants greater liquidity and financial flexibility.
• The business may benefit from fewer traditional financial maintenance covenants.
• Borrowing needs rise and fall with sales, receivables or inventory levels

Transitional situations

• The company is navigating operational change or transformation.
• Existing financing arrangements may no longer provide adequate liquidity or flexibility.

ABL is no longer viewed as a last resort financing option

For the right company, it can be a strategic capital solution that enhances liquidity, supports growth and provides greater flexibility than a traditional cash flow structure. The key question is whether the company's balance sheet could support a more efficient financing solution.

At U.S. Bank, we help companies evaluate asset-based finance and other financing alternatives to determine which structure best aligns with their growth objectives, capital needs and operating profile. Contact your relationship manager to learn more.