Traditional cash flow-based loans continue to be a powerful financial solution, but they aren’t the right fit for every business or situation. For some businesses, a more appropriate source of working capital and growth funding is an asset-based loan (ABL).
Once considered primarily a financing option of last resort for struggling companies, ABL facilities today serve healthy, growing companies across a wide range of industries.
In evaluating a potential ABL borrower, lenders consider not only creditworthiness and balance sheet strength, but also the quality of collateral, such as inventory and accounts receivable. With an ABL, the amount of financing available can increase or decrease based on the value of eligible collateral assets, also known as the “borrowing base.”
ABLs are typically governed by fewer covenants than traditional cash flow loans. Also, because ABL lenders are serving healthier borrowers these days, the transactions are less risky. As a result, ABL pricing is now much closer to that of traditional loans.
Because of these features, ABLs can be a sound alternative for organizations looking to finance rapid growth, support seasonal business fluctuations, address working capital constraints, or fund an acquisition or strategic expansion.
Here are six key questions to help determine whether an ABL may be right for your business:
Not all accounts receivable are eligible to be included in a lender’s ABL borrowing base calculation. In evaluating your application, the bank will start with your gross accounts receivable (AR) and subtract any receivables that are more than 90 days old, foreign AR that aren’t covered by credit insurance, and other high-risk AR. In calculating the borrowing base, a bank will typically limit the percentage of total eligible AR that can be concentrated with a single customer.
Lenders will evaluate the value of your company’s inventory if it had to be liquidated. They will discount obsolete, slow-moving, or other inventory that offers little liquidation value, such as work-in-process inventory that would need to be finished before it could be sold.
Machinery and equipment (M&E) is another source of collateral. What would your M&E bring in a liquidation? Note that custom equipment — for instance, equipment used to produce a single part for a machine needed by only a single customer — would not contribute much to the borrowing base.
Lenders want to feel confident that an ABL borrower has the systems and procedures in place to continuously and accurately monitor collateral value and financial performance. Does your business have:
To learn more about whether an asset-based loan is a good fit for your business, contact your Hancock Whitney banker or Matt Mouledous, Head of Asset-Based Lending. For a more detailed look at ABL financing, download our white paper, Is an Asset-Based Loan Right for Your Business?