Asset-based lending provides a versatile financing solution for mid-sized and large companies to meet a variety of ongoing and event-driven needs. From acquisitions and expansion to ownership succession, businesses continue to discover how asset-based lending can provide an attractive source of financing that enhances organizational growth and expansion efforts.

There are many false perceptions and myths surrounding asset-based lending. A closer look at the components of these loans demonstrates how this versatile lending product applies to all companies, delivers manageable reporting features and is a cost-effective tool to support business goals.

Asset-based lending: An overview

Asset-based lending relies on the value of collateral assets. It includes a revolving credit facility based on current assets like accounts receivable and inventory and may combine with a secured term loan for long-term needs.

An asset-based revolving credit facility relies on a borrower’s current assets, such as accounts receivables and inventory. Funds are provided up to a defined percentage of these assets to improve liquidity and working capital. Additionally, a secured term loan linked with the revolver addresses long-term capital needs like debt refinancing and capital project funding, using assets such as machinery, equipment and real estate as collateral.

Lenders require detailed field examinations and appraisals to monitor assets and conduct field exams to verify their value. While this type of monitoring and oversight is more intensive than traditional lending, many well-managed companies already track this data, and others find it to be a valuable improvement to current management reporting.

For many borrowers, asset-based loans are an attractive alternative to traditional business loans and they continue to gain a wider audience among businesses as well as private equity.

Asset-based lending vs. cash-flow loans

Cash-flow loans are based on a company’s enterprise value — often expressed in terms of earnings before interest, taxes, depreciation and amortization (EBITDA) — rather than the value of the company’s pledged assets. Asset-based loans can provide flexibility and capital efficiency advantages over cash-flow loans because of differences in the credit structures.

Cash-flow loans include restrictive covenants like fixed-charge coverage, capital expenditure limits and leverage requirements, which can restrict borrowing capacity and raise costs if breached. In contrast, asset-based loans are typically less restrictive, offering borrowers more flexibility. For example, asset-based loans typically include only a “springing” fixed-charge coverage ratio covenant that is not tested unless loan availability falls below an agreed-upon percentage of the company’s borrowing base.

Cash-flow loans can be restrictive because they depend on debt/EBITDA, impacted by seasonal and interim change in earnings. Asset-based lending is more stable, relying on the borrower's assets. For instance, a food company faced issues with its credit facility due to seasonal inventory needs conflicting with leverage covenants. Switching to an asset-based revolving credit line allowed the company to double its credit capacity, offering more flexibility and borrowing power based on inventory value.

Asset-based loans are typically fully secured with current assets, potentially lowering borrowing costs compared to cash-flow loans (which may be unsecured or only partially secured). To achieve optimization, a business should mirror credit facilities with its short-term and long-term capital needs and the evaluation process should include an asset-based structure in order to derive the most flexible solution. Asset-based loans provide liquidity and flexibility, complementing other financial tools, like leases, mortgages, subordinated debt, institutional term loans or high-yield debt. Generally, due to the secured nature of asset-based lending, creditors often feel more comfortable with the higher debt/EBITDA or balance sheet leverage.

Candidates for asset-based credit solutions

Asset-based financing solutions can be both prudent and practical for:

• Companies with expansion plans (either organic or via acquisition);
• Seasonal or cyclical businesses encountering cash-flow strains throughout the year;
• Businesses that require liquidity as part of an ownership succession financing plan;
• Organizations undertaking recapitalizations, refinancing and restructurings;
• Turnaround situations.

Asset-based lending presents a compelling financing option for a variety of companies, notably for manufacturers, distributors, wholesalers, retailers and select service businesses. Businesses with strong management teams and disciplined financial reporting capabilities are particularly well-positioned to meet the monitoring requirements of asset-based credit facilities by leveraging a broad array of asset-based lending products, including:

• Secured revolving credit facility against working capital assets;
• Short-term over-advance facilities for seasonal businesses;
• Secured term loan facilities to support long-term assets;
• Senior stretch term loans to support bridge financing.

A business expansion tool

Today, many companies look to asset-based credit to support business expansion, as illustrated in the following examples:

Services. A private East Coast company recognized the opportunity to take its business to the next level with a contract to supply fuel to public agencies and local governments. To be competitive, it needed to increase borrowing capacity and restructure existing debt. An asset-based credit facility enabled the company to leverage its assets for higher borrowing capacity than its traditional loan structure. Additionally, the asset-based credit facility also had fewer covenants and restrictions than the company's existing debt, providing management with greater flexibility to run the business.

Manufacturing. For a privately owned fastener distributor with operations in the United States and Canada, asset-based credit played an important role in refinancing the company’s existing debt. The facility also provided the company with a flexible financing source, helping it expand into new geographic territories.

Any company with an asset-rich balance sheet — especially one comprised of significant accounts receivables and inventory — could find asset-based credit to be an optimal solution for its funding needs.