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Is Asset-Based Lending Right For My Business?

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Today, access to funding can make or break a business’s growth trajectory. Asset-based lending (ABL) has emerged as a lifeline for businesses seeking financing against their existing assets.

In the United Kingdom, around 35,000 businesses across the UK currently benefit from support provided by UK Finance’s IF/ABL members. Prior to the pandemic, these members were advancing over £21 billion to client businesses annually, equivalent to approximately £125 billion in total funding. In 2020, businesses utilising IF and ABL products provided by these members generated a combined turnover exceeding £245 billion, showcasing the significant role ABL plays in facilitating business growth and resilience.

However, as we delve into this financial strategy, it’s crucial to ascertain whether asset-based lending aligns with the unique needs and circumstances of your business. Or better yet, is it right for your business? This is what we will be answering today!

What is asset-based lending?

Asset-based lending (ABL) is a type of business financing in which a loan or line of credit is secured by the borrower’s assets. These assets can include accounts receivable, inventory, equipment, machinery, real estate, or other tangible assets owned by the company. The lender basically assesses the value of the company’s assets and provides a loan or line of credit based on a percentage of that value.

Unlike traditional loans that are based primarily on the borrower’s creditworthiness and cash flow, asset-based lending focuses more on the quality and value of the assets being used as collateral. This makes it a viable option for businesses that may have valuable assets but limited cash flow or may even have a less-than-perfect credit history.

How exactly does asset-based lending works?

Here is a detailed overview of how Asset-Based lending really works:

  1. Assessment of Assets – The first step in asset-based lending is the assessment of the borrower’s assets. This includes a thorough evaluation of various asset classes such as accounts receivable, inventory, machinery, equipment, and real estate. Each asset is scrutinised for its liquidity, market value, and risk factors.
  2. Determination of Advance Rate – Once the assets are assessed, the lender determines the advance rate, which is the percentage of the asset’s value that can be used as collateral for the loan. Advance rates typically vary depending on the type and quality of assets, industry norms, and the lender’s risk appetite. For example, accounts receivable may have a higher advance rate than inventory due to their more predictable cash flow.
  3. Structuring the Loan – Based on the assessed value of the assets and the determined advance rate, the lender structures the loan or line of credit. This includes establishing the maximum borrowing limit, interest rate, repayment terms, and any additional fees or covenants.
  4. Monitoring and Reporting – Asset-based lending requires ongoing monitoring of the borrower’s assets to ensure that the collateral value remains sufficient to support the loan. Borrowers are often required to provide regular reporting on the status of their assets, such as aging reports for accounts receivable and inventory turnover ratios.
  5. Borrowing Base Calculation – The borrowing base is the maximum amount that a borrower can draw under an asset-based lending facility. It is calculated by applying the advance rates to the value of eligible assets. As the value of assets fluctuates, the borrowing base is adjusted accordingly, providing the borrower with access to additional funds or requiring them to repay a portion of the loan.
  6. Collateral Management – Asset-based lenders may require borrowers to provide additional collateral or take specific measures to protect the lender’s interests. This can include the creation of liens or security interests on assets, inventory audits, or the implementation of cash management controls.
  7. Default and Remedies – In the event of default, asset-based lenders have the right to seize and liquidate the collateral to recover their outstanding debt. However, lenders typically work with borrowers to find alternative solutions before resorting to foreclosure or asset liquidation.

Which assets are most considered for asset-based lending?

The most common types of assets considered for this form of financing include:

Accounts Receivable (Invoice Financing) – This is one of the most prevalent forms of asset-based lending. Invoices that are due from customers serve as collateral for a loan. Lenders advance a certain percentage of the invoice value upfront, typically around 70-90%, and the remaining balance, minus fees, is provided once the invoice is paid.

Inventory – Inventory financing allows businesses to use their inventory as collateral for a loan. This is particularly common in industries where maintaining a stockpile of goods is essential, such as retail and manufacturing. Lenders evaluate the quality and marketability of the inventory to determine the loan amount.

Machinery and Equipment – Companies can leverage their machinery and equipment to secure financing. Lenders assess the value and condition of these assets to determine the loan amount. This type of asset-based lending is common in industries such as construction, agriculture, and manufacturing.

Real Estate – Real estate can be used as collateral for asset-based lending, particularly for larger loans. This includes commercial properties, land, and even residential properties owned by the business. Real estate assets are valued based on appraisals and market conditions.

Intellectual Property – Intellectual property assets, such as patents, trademarks, and copyrights, can also be used to secure financing. However, this type of asset-based lending may require specialised expertise to assess the value of intangible assets accurately.

Vehicles – Vehicles owned by the business, such as cars, trucks, or specialised vehicles, can serve as collateral for asset-based loans. Lenders evaluate the condition, age, and market value of the vehicles to determine the loan amount.

Benefits of asset-based lending

Being a dynamic financial strategy, ABL offers a plethora of advantages for both lenders and borrowers, catalyzing growth and providing liquidity in various business landscapes. They include the following:

Enhanced Liquidity – ABL provides an avenue for businesses to unlock the liquidity tied up in their assets, including accounts receivable, inventory, equipment, and real estate. This liquidity infusion enables you to meet your business’s short-term obligations, fund expansion initiatives, or navigate through challenging economic conditions without resorting to equity dilution.

Flexible Financing Structures – Unlike traditional lending products, ABL offers highly flexible financing structures tailored to the unique needs of each borrower. Lenders assess the value and quality of underlying assets rather than solely relying on creditworthiness, allowing for greater flexibility in structuring deals. This flexibility enables businesses to access capital even with less-than-perfect credit profiles or irregular cash flows.

Optimised Working Capital Management – Asset-based lending empowers businesses to optimise their working capital management by leveraging assets effectively. By converting dormant assets into working capital, you can streamline operations, negotiate better terms with suppliers, and capitalise on growth opportunities without straining the business’s cash reserves.

Scalability – ABL facilities are inherently scalable, allowing businesses to adjust their financing needs according to fluctuations in asset levels and operational requirements. As your business grow and asset base expands, you can access additional funding without the need for extensive renegotiations or refinancing processes, thereby supporting long-term growth ambitions.

Risk Mitigation – From the lender’s perspective, asset-based lending offers a higher degree of collateral coverage compared to unsecured loans, thereby mitigating credit risk. Lenders have a direct claim on the underlying assets in the event of default, providing a level of security that traditional unsecured loans lack. This collateral cushion reduces the lender’s exposure to potential losses and enhances overall risk management. This also means that you will easily qualify for a loan.

Support for Turnaround Situations – Asset-based lending can be instrumental in supporting businesses during turnaround or restructuring phases. By leveraging existing assets, distressed business can access much-needed liquidity to stabilise operations, restructure debts, and implement strategic initiatives aimed at returning to profitability. This support can be pivotal in preserving jobs, maintaining supplier relationships, and ultimately facilitating successful turnarounds.

Competitive Advantage – ABL allows businesses to capitalise on growth opportunities quickly and efficiently, giving them a competitive edge in the marketplace. Whether it’s expanding into new markets, investing in R&D, or seizing strategic acquisitions, access to flexible financing can accelerate growth initiatives and position businesses as industry leaders.

Relationship-Based Lending – Asset-based lending often fosters closer relationships between lenders and borrowers compared to transactional lending arrangements. Lenders typically conduct ongoing monitoring of collateral and business performance, providing valuable insights and support to help businesses optimise their operations and financial strategies.

What are the limitations of asset-based lending?

While asset-based lending (ABL) presents numerous advantages, it’s essential to acknowledge the potential drawbacks and challenges associated with this financing approach. Here are a few of them:

Higher Cost of Capital – One of the primary drawbacks of asset-based lending is that it typically comes with a higher cost of capital compared to traditional bank loans. Lenders factor in the risk associated with the underlying assets and may impose higher interest rates and fees to compensate for this risk. Consequently, businesses may incur higher financing costs, reducing their overall profitability.

Asset Valuation Challenges – Asset-based lending relies heavily on the valuation of collateral assets to determine the loan amount. However, accurately valuing certain assets, such as inventory or intellectual property, can be challenging and subjective. Discrepancies in asset valuation may lead to disagreements between borrowers and lenders, potentially delaying the approval process or resulting in lower loan amounts than anticipated.

Covenant Requirements – Asset-based lending facilities often come with stringent covenant requirements aimed at protecting the interests of the lender. These covenants may include financial ratios, asset coverage ratios, or performance benchmarks that borrowers must maintain throughout the loan term. Failure to meet these covenants can trigger default provisions, leading to penalties, higher interest rates, or even the acceleration of loan repayment.

Limited Availability for Certain Assets – While asset-based lending can accommodate a wide range of collateral assets, certain types of assets may be less liquid or desirable as collateral. For example, specialised equipment, intellectual property, or unique inventory items may have limited resale value or marketability, making it challenging for borrowers to secure financing against these assets.

Potential for Asset Concentration Risk – Asset-based lending may exacerbate asset concentration risk for businesses that rely heavily on a few key assets to secure financing. If the value of these assets declines significantly or becomes impaired, it could jeopardise the borrower’s ability to repay the loan and result in financial distress. Diversification of assets and revenue streams is crucial to mitigate this risk.

Potential for Negative Perception – In some cases, relying on asset-based lending may signal financial distress or instability to stakeholders, including investors, suppliers, and customers. While ABL can be a strategic financing tool, businesses should consider the potential implications of utilising asset-based financing on their reputation and relationships with key stakeholders.

What are the eligibility criteria for businesses seeking asset financing?

Eligibility criteria for businesses seeking asset financing in the UK can vary depending on the lender and the type of asset finance being sought. However, some common eligibility criteria include:

Business Status – Firstly, the business must be legally registered and operating within the United Kingdom. This includes being compliant with all relevant regulations and tax requirements.

Type of Asset – Different lenders specialise in financing various types of assets, such as machinery, vehicles, technology equipment, or even intangible assets like software licenses. The asset being financed must be eligible under the lender’s financing program.

Value of Asset – Lenders typically have minimum and maximum values for assets eligible for financing. The value of the asset being financed will influence the terms of the financing arrangement, including the down payment required and the repayment schedule.

Repayment Ability – Businesses need to demonstrate their ability to repay the financing. This involves providing detailed financial projections, cash flow statements, and business plans to show that the investment in the asset will generate sufficient returns to cover the financing costs.

Business Performance – Lenders assess the overall performance of the business, including factors such as revenue growth, profitability, and stability. A track record of financial success can improve the likelihood of approval and may lead to more favourable terms.

Deposit or Collateral – Depending on the lender and the specific financing arrangement, a deposit or collateral may be required to secure the financing. This provides the lender with assurance that they will recoup their investment in the event of default.

Legal Requirements – Businesses must comply with all legal requirements related to the asset being financed. For example, if the asset is a vehicle, it must be properly registered and insured according to UK law.

Industry and Sector – Some lenders specialise in financing specific industries or sectors. Businesses operating in niche industries may need to seek out lenders with expertise in their field to ensure they meet all eligibility criteria.

Duration of Financing – The duration of the financing agreement can vary depending on the type of asset finance chosen (e.g., lease, hire purchase). Businesses should consider their long-term needs and objectives when selecting the most appropriate financing option.

What do I need to consider before using asset-based lending?

Before diving into asset-based lending in the UK, it’s crucial to understand its intricacies and assess its suitability for your financial needs. Here are several key considerations:

Asset Evaluation – The cornerstone of asset-based lending is the value of your assets. Conduct a thorough assessment of your assets to determine their current market value. This includes inventory, equipment, accounts receivable, and property. Ensure that your assets are accurately appraised by professionals to avoid any discrepancies.

Eligible Assets – Different lenders may have varying criteria regarding eligible assets. While some lenders accept a wide range of assets, others may have restrictions. Familiarise yourself with the lender’s requirements to ensure that your assets meet their criteria.

Loan-to-Value Ratio – Lenders typically advance a percentage of the value of your assets as a loan. This loan-to-value ratio varies based on factors such as the type of asset and its perceived risk. Understanding the loan-to-value ratio is essential for gauging how much funding you can access.

Repayment Terms – Asset-based loans often come with flexible repayment terms. However, it’s vital to comprehend the terms of repayment, including interest rates, frequency of payments, and any penalties for late payments. Ensure that the repayment structure aligns with your cash flow projections and business objectives.

Risk Assessment – While asset-based lending can provide access to capital, it also entails risks. Failure to repay the loan could result in the seizure of your assets by the lender. Conduct a thorough risk assessment to evaluate your ability to meet repayment obligations and mitigate potential risks.

Legal Implications – Engage legal counsel to review the terms and conditions of the loan agreement. Ensure that you understand the legal implications, rights, and obligations associated with asset-based lending. Clarify any clauses related to default, recourse, or asset valuation methodologies.

Impact on Business Operations – Consider how asset-based lending will impact your day-to-day business operations. Assess whether leveraging your assets for financing could affect your ability to fulfill customer orders, maintain production levels, or invest in growth opportunities.

Alternative Financing Options – Explore alternative financing options to determine the most suitable solution for your financial needs. Compare the terms, costs, and benefits of asset-based lending with other forms of financing, such as traditional bank loans, lines of credit, or equity financing.

Lender Reputation and Experience – Choose a reputable lender with experience in asset-based lending. Research the lender’s track record, customer reviews, and industry expertise to ensure a smooth lending process and reliable support throughout the loan term.

Regulatory Compliance – Familiarise yourself with regulatory requirements governing asset-based lending in the UK. Ensure compliance with relevant laws, regulations, and industry standards to avoid potential legal issues or penalties.

Conclusion

In conclusion, for businesses in the UK, asset-based lending can be a valuable financial tool to consider. Its flexibility and accessibility make it a viable option for businesses seeking to leverage their assets to secure funding. By unlocking the capital tied up in assets such as inventory, equipment, and accounts receivable, the businesses can access the working capital they need to fuel growth, manage cash flow, and navigate economic uncertainties. However, it’s essential for businesses to carefully evaluate their specific needs, assess the costs and risks associated with asset-based lending, and maybe even explore alternative financing options before making a decision.

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