The Basics of Asset Based Lending

Blog_-_VCF_2.pngAn asset based loan is a specific type of business loan that is secured by the business’ current assets, typically accounts receivable (“A/R”) and inventory (“INV”). Thanks to their versatility, asset-based loans can be valuable in a number of different situations. Many organizations use them as a form of bridge financing, which may be necessary if the business is having difficulties getting the financing they need through a more traditional line of credit or term loan.

An Alternative to Traditional Loans

Maybe your business has good credit and decent cash flow, but does not have strong equity or sufficient fixed assets. Or maybe the business has good credit and strong equity, but recent business factors have strained cash flow resulting in monthly or annual losses. In the majority of cases, you would be turned down for a traditional line of credit or term loan through the bank.

These scenarios present a perfect opportunity to consider Asset Based Lending (“ABL”). While ABL does look at the strength of the business’ balance sheet and its financial ratios, the primary focus is on the performance of the business’ current assets, primarily A/R and INV.

How does ABL actually work?

Most asset-based loans are structured as a revolving line of credit (“RLOC”). The RLOC is one in which your loan availability is determined by specified advance percentages against the eligible A/R and INV. You are thus able to calculate the loan amount available and only have to borrow what is necessary to cover daily, weekly, and monthly expenses. In this respect, the RLOC is more flexible than a traditional line of credit or term loan because there is never a requirement for you to borrow more than what is actually needed. Just as importantly, as your eligible A/R and INV grow, so does your borrowing availability.

How does the loan get paid back?

Unlike a traditional line of credit or term loan where there is a specific monthly payment, the RLOC is paid down when your customers pay their invoices. Typically, a Cash Collateral Account (“CCA”) is opened by the lender in the name of your company. You then inform your customers of the new address to which they will remit their payments. The customers only see a change in the payment address and are not notified that their A/R has been assigned to the lender. This process is known as “taking dominion of cash” and is a standard industry component of ABL. The advantage of this mechanism to you as the borrower is twofold; quicker loan pay-downs and immediate notification of any incoming check. The need to take deposits to the bank is eliminated.

Putting it all together

You report your current A/R and INV balances via a Borrowing Base Certificate (“BBC”). The BBC shows your A/R activity including sales, debit or credit memos, discounts, adjustments, and payments. Your loan availability is then calculated based on the predetermined advance rate less your current outstanding loan balance, thus showing the net loan availability for additional advances against the RLOC.

As new sales are made and invoices are generated, additional loan availability is created off of the new invoices. This gives you immediate cash availability rather than having to wait until your customer actually pays the invoice. When your customer does pay the invoice and the payment is remitted to the CCA account, then your loan balance is reduced by the amount of the payment. This scenario is the true essence of a RLOC versus a traditional term loan.

Increased Business Flexibility

The RLOC is a viable alternative to a traditional line of credit or term loan. As your business strives to expand or recover from a “bump in the road,” the RLOC can be an innovative solution to your cash flow needs.