Asset Based Lending
Asset Based Lending, or ABL, is a business loan secured by balance sheet assets, including cash, accounts receivable and sometimes inventory. The amount of the credit offered through the loan depends on the value of the pledged assets, securing the loan (i.e. the collateral). It is a viable alternative for businesses that are looking to improve cash flow by monetizing these assets.
Asset based lending is a revolving credit facility, similar to a credit card, made to business “borrowers that may have high leverage, erratic earnings, or marginal cash flows.”1
But, ABL can also appeal to financially stable businesses. Sometimes, the loan can be secured by tangible fixed assets such as property, plant and equipment.
How Asset Based Lending Works
Here is a simplified example of how an asset based lending transaction might occur. A business that is factoring invoices asks about a loan or line of credit. The factoring company performs due diligence on the business’ balance sheet assets and determine which are ‘eligible collateral’ for the loan. The loan will be based on a percentage (the advance rate) of this collateral known as the borrowing base. The quality of the collateral comes under review.
Asset Based Lending Pros
Using an ABL may allow the business to receive short term funding and avoid breaching a financial covenant. The line is repaid by the assets being converted to cash over the course of the business cycle. Asset based lending can help high growth companies get an investment in working capital. ABL is also flexible and can help businesses that operate in seasonal industries get uneven funding.
Asset Based Lending Cons
While asset based lending is often considered a step up from invoice factoring, it comes with its own negatives. For one, the interest rate the business will pay will on the factor’s revolving credit facility will likely be higher than that for a traditional business line of credit. The line of credit can also be cut by the invoice factoring company, so there is always that uncertainty. If the bond bubble pops as some market watchers predict, credit could prove very difficult to obtain. Remember during the Great Recession, credit creation came to a standstill. The total amount and number of loans issued dried up, especially revolving lines of credit (red line) and term loans (blue line).*
Who Uses Asset Based Lending?
If your business operates in an asset-intensive business such as transportation (the trucks or long haulers), printing (presses) and oil and gas and businesses that sell seasonal products for major holidays. Asset based lending is often utilized in companies that operate in commodity-based industries whose price fluctuates such as the oil & gas industries.
Asset Based Lending vs Invoice Factoring
Asset Based Lending is another type of small business funding offered by many invoice factoring companies. Similar to a line of credit, ABL is often viewed as a step above invoice factoring because the business is now becoming more bankable. Accounts receivable factoring involves the sale of assets to provide cash flow.
Many invoice factoring companies offer invoice factoring as well as asset based lending or invoice financing. Sometimes, clients will start factoring receivables, then move up to a revolving line of credit offered by the factor. Factoring companies offer asset based lending since they’re already familiar with the asset quality. So, it’s a logical next step to also offer lending based on all the business’ current assets, which may include inventory.
When looking for an invoice factoring company, consider those which have the financial resources to also include ABL when your company has grown enough to capitalize on this source of financing. Factoring accounts receivable is a viable cash flow funding option, especially when credit is tight in an economy.