Does your organization have accounts receivable and inventory that can be leveraged to improve liquidity? The nature and quality of your working capital can make all the difference.
Companies that maintain high levels of quality working capital assets and produce modest cash flow are ideal candidates for an asset-based loan (ABL).
Current asset collateral is key for leveraging an asset-based loan. Manufacturers, distributors and retailers are good candidates for ABLs as they invest significantly in working capital and, in some cases, produce relatively low free cash flow (FCF).
“An ABL can be perfect for a company of this profile, particularly if they are poised for rapid growth, acquisitions or considering a shareholder buyout,” says Dave Slavik, senior vice president for U.S. Bank Asset Based Finance.
The traditional way to measure senior debt capacity is a function of cash flow, typically calculated as a three to four time multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). ABL uses a borrowing base predicated on working capital liquidation values, which typically range from 50-75% for inventory and 85-90% for accounts.
Many companies can generate higher debt capacity via a borrowing base, rather than traditional commercial loans.
“Lenders specializing in asset-based loans look for collateral that’s liquid,” Slavik adds. The stack-rank asset preference is typically as follows:
“The higher an asset is in the ranking, the more liquid it is,” Slavik explains. “Ideal collateral are accounts receivable or inventory that’s easily valued and monetized. These include commodities such as metal, lumber, food, fuel or oil. Generally, the faster the asset's turnover, the more attractive it is as collateral.”
Conversely, ineligible assets are usually those with lower value or those that may be subject to material shifts in consumer trends. For example, a wholesaler of shingles is considered stable because the size, look, construction and volume of inventory isn’t likely to experience material year-to-year changes. This stability isn’t the same for a wholesaler of apparel or technology-based products. Both examples are subject to potential obsolescence due to changes in demand trends and product mix.
>> Learn more: Contact us to discuss how ABL can fuel your growth strategy.
For purposes of securing an ABL, lenders find the following collateral less desirable:
Large facilities, such as a steel mill or foundry, are challenging as collateral, but multipurpose buildings like warehouses near dense city centers are not.
“Inventory subject to trademarks can also be challenging,” Slavik adds, “mainly due to the potential for the trademark owner to restrict liquidation channels in an effort to protect its brand. Also, inventory considered to be work in process is typically not eligible for borrowing or will have a reduced advance rate.”
Lenders often start the process of evaluating a borrower by dispatching field examiners to review their working capital assets. If applicable, third party appraisers are also engaged to evaluate inventory, machinery and equipment, and real estate. After funding, the lender tracks adjustments in value through periodic field exams and inventory appraisals. As a borrower, you will be asked to submit reports at least monthly, that reflect changes in the quantity and/or value of your pledged assets.
Organizations that are looking to work with an ABL facility should consider these questions when looking for potential partners:
Costs can vary by lender, but most borrowers can expect to pay loan costs – such as a closing fee, a direct interest charge, unused fees and modest monitoring fees. Despite more aggressive leverage tolerance and higher advance rates, ABL pricing is competitive with traditional cash-flow structures due to the ABL product having historically low losses industry wide.
At U.S. Bank, we’re here to help you decide if an ABL is right for your organization. Contact your relationship manager or visit usbank.com to learn more.
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