The Asset-Based Lending Option - for Businesses Big and Small
Alternative lending has gained footing in recent years, and statistics predict that businesses will continue seeking alternative forms of funding, especially as millennials become business owners. A recent
Bank of America survey
reported that 14% of US millennial business owners have turned to non-traditional lending services.
Additionally, since the economic downturn, banks have been reluctant to lend to small businesses. Although lending has increased recently as America’s economic recovery picks up,
Crain’s reports
that in January US small banks only approved 49.8% of loans and credit unions approved only 43.5% of applications.
Asset-based lending (ABL) has proved to be a relatively low-risk lending option for companies seeking working capital – small businesses that struggle to obtain a traditional loan, as well as large businesses seeking funding for an acquisition, merger or expansion.
Asset-based loans offer business owners more flexibility, as they are based on the collateral put up for the loan – as opposed to traditional bank loans, which are determined by a company’s current cash operations and projected cash flow.
Structure
An asset-based loan is typically offered as a secured revolving line of credit backed by four main assets: accounts receivable (AR), inventory, equipment and real estate. Some lenders also offer additional funding based on intellectual property or cash flow, in addition to a business’s assets. In ABL, assets are assigned a value and banks or lending institutions offer funding based on a percentage of that value.
A company’s AR and inventory provide businesses with a revolving line of credit and are appraised on a regular basis, whereas equipment and real estate are usually structured or term loans. When appraising inventory, the industry standard is to loan approximately 80% of the net orderly liquidation value (NOLV). NOLV is an estimate of the net value of the assets, were they to be liquidated in order to repay the debt. Meanwhile, equipment is typically appraised on an orderly liquidation value or forced liquidation rate, with loans given at 75% of the forced liquidation value (FLV).
While relatively affordable, asset-based loans typically come with headline fees, in which borrowers are charged an interest rate based on the amount borrowed. Additionally, most asset-based loans require quarterly audits and annual appraisal fees associated with the appraisal of assets, which is used to determine the loan amount. Businesses may also incur unused line fees or collateral management fees, if the full loan amount is not expended.
Popularity
As companies continue to seek alternative forms of funding, the ABL industry continues to grow. Institutions loaned nearly US$20bn in asset-based loans in the third quarter of 2014, well above 2013’s Q3 volume of US$14bn, according to
Thomson Reuters
.
Although small and medium-sized enterprises (SMEs) have long looked to ABL for funding day-to-day operations, in recent years it has also extended to big business for a number of reasons. Typically, large businesses turn to ABL because of a “need-driven” event, such as expansion, mergers or acquisitions. ABL allows for a relatively low-risk alternative to revenue generation for companies looking to acquire a new business without owners or shareholders contributing additional funds.
Risks
Although ABL is generally considered a low-risk option for both businesses and lenders, there are still risks associated with the practice. While banks and lending institutions provide financing based on the NOLV, these lenders still face the possibility of a business misreporting its AR. Additionally, lending to a failing industry or one that is highly-regulated also poses potential risks for lending institutions.
Small business owners should ensure their business has the capacity to meet the stringent reporting requirements associated with ABL, as well as a seasoned and capable chief financial officer (CFO) or controller. It’s important that businesses present their assets in an upfront manner and not overreach in terms of the loan amount. In many facilities, owners are personally liable and falling out of formula on an asset-based loan could impact his or her own financial net worth.
When seeking an asset-based loan, borrowers should talk to several asset-based lenders and bring in a certified personal accountant or advisor to help explain the term agreements. It’s important to learn what bank and non-bank lenders, as well as large, regional and community banks offer in order to gain a holistic understanding of the available options. Generally, there is an asset-based lender for every company – many are industry-specific, providing funding to only technology, healthcare or consumer-product focused companies, for example.
Also, businesses should always ensure an attorney reviews the contract before accepting the terms. Lastly, it’s important that a business is comfortable with the lending institution of its choice and heavily researches the institution’s trustworthiness and stability.