Does your organization have assets that can be leveraged for borrowing? The nature of your working capital, the quality of your accounts receivable and the type of inventory you hold can all make a difference.
Asset-based loans (ABLs) are useful for many large retailers, manufacturers, distribution companies and other businesses that carry high inventory levels. An ABL can be perfect for an organization that’s poised for rapid growth, but lacks the cash flow often required by traditional lenders.
“Candidates may need liquidity for acquisitions or shareholder buyouts,” says Jim Doyle, senior vice president for U.S. Bank Asset Based Finance. “Many companies can generate a much higher borrowing base through their collateral than their level of earnings would provide from a traditional commercial loan.”
“Lenders specializing in asset-based loans look for collateral that’s liquid,” adds David Slavik, senior vice president for U.S. Bank Asset Based Finance. The hierarchy of asset preference is usually as follows:
4. Real estate
“The higher these assets are in the hierarchy, the more liquid they are,” Slavik says. “Ideal collateral are accounts receivable or inventory that’s easily valued and monetized. These can include grains, fuel or oil. They’re always advantageous because their markets move fast.”
Conversely, ineligible assets are usually those with lower value or those that may be subject to volatile shifts in consumer trends. For example, a roof shingle wholesaler is considered stable because the size, look, construction and volume of inventory isn’t likely to experience year-to-year changes. This desirable stability isn’t the same for a wholesaler of apparel or technology — two inventories that are subject to potential obsolescence due to shifts in demand, availability or preference.
For purposes of securing an ABL, lenders find the following collateral less desirable:
• Receivables that are past due or subject to high dilution levels
• Foreign receivables without insurance
• Inventory that’s primarily seasonal, specialized or consigned
• Single purpose real estate or equipment that can be difficult to monetize
Large facilities, such as a steel mill or foundry, are challenging as collateral, but multipurpose buildings like warehouses near dense city centers are not.
“At U.S. Bank, when we evaluate a loan candidate, other types of less desirable collateral would be slow moving or obsolete inventory,” Doyle adds. “If we need to realize value on such assets, it may take longer and may result in less value.”
“Inventory subject to trademarks is also challenging,” Slavik adds, “because there’s the potential for the trademark owner to restrict the eligibility of certain buyers in an effort to protect its brand. Also, inventory consisting of goods that are in the midst of manufacturing, but are not yet completed, is typically not eligible for borrowing.”
Lenders often start the process of evaluating a borrower by dispatching field examiners to review their working capital assets. If applicable, third party appraisers are also engaged to evaluate inventory, machinery and equipment, and real estate. After funding, the lender tracks adjustments in value through periodic field exams and inventory appraisals during the lending period. As a borrower, you may be required to file reports, at least monthly, that reflect changes in the quantity and/or value of your working capital assets.
At U.S. Bank, we recommend that you prepare for your initial conversation with a lender by examining your collateral to determine eligibility. You should also calculate your rate of dilution, defined as the amount you bill. That is, ultimately, not collected as a percentage of the original sale. “We prefer receivables that don’t have a lot of dilution,” Doyle says, noting that the ideal range is five percent or less.
This kind of preparation may be an ongoing effort, as monitoring can continue throughout the duration of the loan period.
Costs can vary by lender, but most borrowers can expect to pay loan costs — such as a closing fee, a direct interest charge, unused fees and modest monitoring fees. Despite more aggressive leverage tolerance and higher advance rates, ABL pricing can be competitive with traditional loans, because it has a proven track record in minimizing lender losses.
Moving to an ABL structure can be ideal for organizations such as retailers, wholesalers or manufacturers — these entities often have a long-range plan for profitability in place and expect a positive turnaround sooner rather than later. ABLs can give your organization the immediate ability to increase your working capital, especially if you’re in a period of rapid growth but lack the credit rating or the track record to qualify for a traditional loan.