Asset-based lending refers to loans secured by a wide variety of assets. Businesses can borrow money using the liquid, current assets of the company (such as accounts receivable and/or inventory) or the fixed assets of a business (such as plant, property and equipment) as collateral. Asset-based lenders rely on the value of the underlying collateral to minimize the loan's credit risk. Asset-based lenders are sometimes referred to as Secured Lenders.
The primary difference between asset-based lending and traditional lending is what the lender looks to when underwriting a loan. A traditional lender will look first to the cash flow then to collateral. An asset-based lender looks to collateral first. Since traditional lenders underwrite cash flow as their primary repayment source, they typically require less collateral controls and monitoring but more financial covenants.
For asset-rich companies, an asset-based loan may make more funds available because it is not based strictly on the anticipated levels of cash flow. Additionally, the structure often requires fewer covenants, providing more flexibility for many borrowers.
A revolver is a loan that can be drawn down and repaid. In a business context, a revolver frequently is secured by the borrower's receivables and/or inventory. This kind of asset-based loan is designed to optimize the availability of working capital from the borrower's current asset base.
The borrower grants a security interest in its receivables and/or inventory to the lender as collateral to secure the loan. Advance rates are applied against the pledged collateral, which creates the borrowing base for the loan. As receivables are paid, the cash is turned over to the lender to pay down the loan balance. When the borrower needs additional working capital, the borrower requests another advance. The lender manages the borrowing base and the related collateral in order to offer the borrower the largest possible loan amount at any given time. Because the borrower's customers are generally not notified of the assignment of the accounts to the lender, the borrower continues to service its receivables. The borrowing arrangement is usually transparent to the borrower's customers.
The outstanding loan amount with a revolver secured by receivables and/or inventory may fluctuate on a daily basis. With a term loan, the outstanding amount is fixed for a period of time, ranging from as brief as one month up to ten years. A term loan generally provides for an agreed-upon payment schedule, and amounts paid on a term loan generally cannot be re-borrowed. In contrast, a revolver allows the borrower to borrow, repay and re-borrow as needed over the life of the loan facility. There are advantages to both revolvers and term loans depending on the borrower's needs. The structure of revolvers provides a great deal of flexibility for borrowing and repayment. Most companies secure a revolver with current assets, such as receivables and inventory, and use the borrowed funds to finance working capital needs. In contrast, companies tend to secure term loans with fixed assets, such as property and equipment, and use the borrowed funds to finance longer-term needs and additional capital equipment.
This is typically a loan that is based on a certain percentage of the net orderly liquidation value of the machinery and equipment and the appraised fair market value of the land and buildings. Asset-based loans against equipment and real estate are often made in the form of term loans that include regular periodic payments of both principal and interest in order to retire the debt at a fixed maturity date. Asset-based loans using real estate as collateral have longer amortization schedules than equipment loans because of the generally shorter economic life expectancy of equipment.
A revolving credit facility, also known as a revolver, is designed to optimize the availability of working capital from the borrower's current asset base. As the borrower repays a portion of the loan, an amount equal to the repayment can be borrowed again under the terms of the agreement. Eligible assets commonly included in calculating the current asset base are accounts receivable and inventory.
The term revolver is used because the amount the asset-based lender is willing to lend increases if the amount of the assets securing the loan increases. Funds are loaned to a company based on a certain percentage of the value of eligible accounts receivable and inventory.
A revolving line of credit typically has a term of one to five years with renewal provisions. The advantage of a revolving credit facility is that the company can use current assets as collateral to secure a loan rather than waiting until the collateral has been converted to cash.
A revolver accelerates cash flow by enabling a business to borrow against the future value of receivables and/or inventory that are expected to become cash in the near term. This acceleration of cash provides liquidity and allows the borrower to extend and optimize its equity base.
Yes. An asset-based loan is commonly used to finance acquisitions. This can be especially advantageous when the prospective acquisition has a high level of eligible receivables and/or inventory in relation to the purchase price of the company. Such companies are often excellent prospects for acquisition, and asset-based lending can provide a significant source of the acquisition capital.
Yes. A revolving credit facility will tend to give a business the greatest amount of flexibility and borrowing capacity from its existing asset base. An innovative asset-based lender can design a facility that can grow as the company grows. For example, a revolving credit facility could be designed to provide a higher credit limit as the business increases its borrowing base, provided certain key operating ratios are maintained. As the company's needs and collateral grow, so can its ability to borrow.
A lender customarily confirms financial and collateral information provided by the borrower in order to support ongoing loan requests. The level of controls and frequency of monitoring by the asset-based lender are directly related to the creditworthiness of the borrower.
Typical controls include:
Borrowing Base Formula: A borrowing base formula monitors the relationship between the value of the collateral available to secure the outstanding loan and the actual balance of the loan on a regular basis. Funding controls, or collateral reporting, may be required daily, weekly or monthly, and range from submission of sales invoice documents to accounts receivable agings and inventory listings.
Field Examinations: Many major lending organizations have a field examination group that visits the borrower's operation to better understand its business. Field examinations benefit the borrower because they enable the lender to provide the maximum amount of liquidity possible that can be supported by the collateral. A field examination is not like the audit a CPA firm would conduct at a business. Instead, it confirms collateral and financial information and helps the lender evaluate trends in the borrower's business.
An important aspect of asset-based lending is that prospective borrowers do not have to be profitable or have a minimum net worth. A business with tangible assets and qualified management can use its assets to create additional working capital to help carry out its business plans.