If your company needs liquidity, an increasingly popular way to obtain it from a bank is through an asset-based loan (ABL) structure.
An ABL is a specialized loan product in which financing is predicated not only on the creditworthiness of the borrower and strength of its balance sheet, but also on the quality and value of the collateral provided to support the extension of credit. ABL has emerged as the structure of choice in good times, for companies of all sizes across a wide range of industries, and is an especially attractive alternative in challenging times when cash flow is strained.
Companies may turn to asset-based finance to obtain the liquidity they need for purposes such as effectuating buyouts, funding dividends, developing new product lines (both financing working capital builds and/or capital expenditures) or simply providing liquidity for working capital purposes.
ABL structures are primarily revolving lines of credit, though some include a term loan component. Various types of collateral can be used to secure an ABL facility, including accounts receivable, inventory, machinery and equipment, real estate and, in some instances, intellectual property.
ABL financing is formula-driven against pledged assets. For example, a borrower may have an ABL credit facility which allows for borrowings up to 90% of the value of its eligible accounts receivable and 75% of the value of its eligible inventory.
What makes an ABL appealing to many companies is its flexibility. The availability of financing expands and contracts with the corresponding availability of a company’s assets, which means ABL is especially attractive for companies in these situations:
By leveraging a company’s balance sheet, an ABL facility can provide many borrowers more liquidity than a traditional cash flow revolver.
Another major advantage: ABLs have fewer covenants than traditional cash flow loans. An ABL is typically governed by a single fixed-charge coverage covenant.
In exchange for this covenant flexibility, the ABL lender requires a cash dominion mechanism to be put in place prior to closing. In its simplest form, the cash dominion mechanism allows for A/R cash receipts to directly pay down the outstanding ABL revolver. The borrower can then re-borrow under the facility to fund operations. For many borrowers, this requirement can be structured to “spring” at an agreed upon minimum liquidity threshold.
“Essentially, a traditional cash flow facility and an asset-based facility are underwritten based on the same criteria, but in a different order,” says John Freeman, Managing Director, Working Capital Finance at U.S. Bank.
“A traditional revolving facility is primarily underwritten to the predictability of a borrower’s cash flow performance and is sized based on a leverage multiple,” he explains. “But a committed ABL facility is an alternative senior secured facility which is primarily underwritten, and sized, based on value of the assets which the borrower chooses to pledge as security for the loan.”
A traditional cash flow revolver is underwritten based on:
An ABL underwriting prioritizes collateral and liquidity and is based on:
“With a revolver-only facility the typical FCC covenant is set at 1.0x,” Freeman noted, “and with a revolver plus term loan facility, the typical FCC covenant is set at 1.10x or higher.”
The ABL is secondarily underwritten to the historical and projected financial performance of the borrower. As part of the diligence process, an ABL lender will perform an initial field exam and appraisal(s) which will primarily focus on establishing an agreed upon borrowing base formula.
Both the field exam and appraisals (inventory, RE, M&E, and IP) will be part of the on-going ABL collateral monitoring. Additionally, the company will be required to submit an updated Borrowing Base Certification (BBC) on a periodic basis, typically monthly or weekly, based on excess availability metrics. That said, borrowers are now able to utilize software which automates much of the reporting requirements. Such technology provides ABL reporting efficiencies that had not existed historically.
Organizations that are exploring a transition from an existing cash flow facility to an ABL facility should seek to partner with a lender that has both a seasoned ABL team along with a wide breath of ancillary banking product solutions which can provide the borrower with greater efficiencies and ample capital, at the lowest cost, available for continued growth.
Here are several criteria to consider before choosing an asset-based lender:
Do they want a relationship — or just a transaction? It’s always best to work with a lender that wants a relationship with your company. In tough times, conducting business is always smoother when the borrower and the lender know each other well and have built a level of trust and transparency.
Do they listen? Anyone can calculate an advance rate. But does the lender exhibit a willingness to dig in to understand your business, think creatively and tailor a solution to meet your specific needs?
Do they have experience in your industry? A major determinant of a lender’s ability to add value to an asset-based structure is its understanding of your business. U.S. Bank, as one of the nation’s largest ABL lenders, has a deep understanding of many specialized industries, which can benefit from an ABL construct. This knowledge enables us to provide industry-specific solutions and enhance our ability to fit your needs.
How long have they been in the business? Lenders have tended to come and go in the ABL business. Ensuring that your lender has an extensive track record, one that illustrates an ability to provide this type of financing throughout multiple stages of the economic cycle, will serve your business well long-term.