Asset Based
Finance
as a Financing Tool
As companies confront a
tight credit market coupled with lower than expected results, many CFOs
are viewing asset based finance as a viable option in the financing tool
kit. Even successful companies with strong banking relationships can
quickly fall out of favor with lenders and lose access to unsecured
financing, especially if they’ve shown recent losses. A few bad quarterly
results doesn’t necessarily mean that a company is in bad shape, but
stringent bank underwriting parameters can cause existing loans to be
called and prevent the firm from qualifying for new financing. A company
facing such a scenario can use asset based lending (ABL) arrangements as
bridge loans to pay off banks and provide liquidity until bank financing
is achievable.
What is asset based
lending?
An asset-based loan is
secured by a company's accounts receivable, inventory, equipment, and/or
real estate, whereby the lender takes a first priority security interest
in those assets financed. Asset-based loans are an alternative to
traditional bank lending because they serve borrowers with risk
characteristics typically outside a bank's comfort level. These assets
typically have an easily determined value. The financing can take the form
of loans to revolving credit lines to equipment leases and can range from
$100,000 to $1 billion, depending on needs and circumstances.
How can ABL be a
beneficial financing option?
Acquisition
To grow a business, a
company may look to acquire a strategic partner or even a competitor.
Asset-based financing is often an efficient means to obtain funding for
business acquisitions.
Turnaround Financing
Turnaround financing is
often used by under-performing businesses that are not achieving their
full potential. In some cases, it is used for businesses that are either
insolvent or on their way to becoming insolvent. Asset-based lenders are
accustomed to the bankruptcy process and asset-based financing is ideal
for turnarounds because of its flexibility.
Capital Expenditures
Capital expenditure is the
money spent to acquire and/or upgrade physical assets such as buildings
and machinery. Capital expenditure is also commonly referred to as capital
spending or capital expense.
Debtor-in-Possession
(DIP) Financing
Debtor-in-possession (DIP)
refers to a company that has filed for protection under Chapter XI of the
Federal Bankruptcy Code and has been permitted by the bankruptcy court to
continue its operations to effect a formal reorganization. A DIP company
can still obtain loans--but only with bankruptcy court approval. DIP
financing, which is new debt obtained by a firm during the Chapter XI
bankruptcy process, allows the company to continue to operate during a
reorganization process. Asset-based lenders also provide exit financing or
confirmation financing to companies coming out of bankruptcy.
Growth
Typically, as a company
grows so does its need for financing. Also, as a company's collateral
grows, its assets can strengthen its ability to borrow. An experienced and
creative asset-based lender can assemble a credit facility that can scale
to grow with a company.
Recapitalization
Recapitalization is the
process of fundamentally revising a company's capital structure. A company
might recapitalize due to bankruptcy or replacing debt securities with
equity in order to reduce the company's ongoing interest obligation. A
leveraged recapitalization typically achieves just the opposite--by taking
on a material amount of debt, the company increases its ongoing interest
obligation but is able to pay its shareholders a special dividend.
Refinancing/Restructuring
When a company enters or
exits a growth stage, refinancing or restructured financing may be key to
creating a capital structure that better meets the needs of the company.
This type of financing is often used for market expansion, completing an
acquisition, restructuring operations, or following a successful corporate
turnaround.
Buyout
A buyout is the purchase of
a controlling percentage of a company's stock. In a leveraged buyout (LBO),
the acquiring company uses the minimum amount of equity to purchase the
target company. The target company's assets are used as collateral for
debt, and its cash flow is used to retire debt accrued by the buyer to
acquire the company. A management buyout (MBO) is an LBO led by the
existing management of a company.
What are the advantages
to ABL?
· Tends to feature fewer
covenants than other types of financing and those it does include tend to
be more flexible. Cash flow loans, by contrast, often have four or five
covenants including total leverage, fixed charge coverage, and minimum net
worth.
· If a company is growing,
the receivables and inventory it uses to secure the asset based loan is
likely growing as well. Thus, the company has a greater collateral base
and can borrow funds to fuel its growth.
· ABL instills discipline.
Since the loans are based upon accounts receivable and inventory, the
company is motivated to improve collections and complete the production
cycle in a timely manner.
· As mentioned earlier, ABL
imposes less stringent covenants compared to cash flow loans. These type
of loans also provide better security to the lenders, which in turn allows
them to grant more time to the borrowers to turn their company around in
difficult times.
What are the
disadvantages of ABL?
· Since the level of
funding is contingent upon the asset values on the balance sheet, there
may not be sufficient liquidity. Only asset rich companies would likely
benefit, while many service companies would not.
· Such a requirement can be
difficult for the company.
· Asset based lending tends
to be more expensive than other types of financing, often three to five
percentage points above traditional bank financing.
· ABL runs counter to the
thinking of a lot of CFOs who believe it is dangerous to tie short term
assets to long term financing.
Although ABL is now a
common financing tool, it is not for everyone. It makes sense to explore
all types of financing before deciding if asset based lending is the right
choice. The CFO must review the state of the company’s credit, analyze the
firm’s asset structure, and its current debt load. Asset based lending can
provide the liquidity needed for the company to grow until less expensive
bank financing is available.
|
Kent Harlan has
been a CPA since 1984 and has provided consulting, accounting and
financial services to several industries. He is the owner of Ozarks
Capital Funding, LLC, a Springfield, MO based company offering
financing in the areas of accounts receivable factoring, equipment
leasing, asset based lending, and healthcare provider financing.
Website:
http://www.ocflink.com |
