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February 22, 2006
Asset-based lending can be a viable option for a troubled company
The number of commercial loans advanced to U.S. businesses fell in 2002 for the third straight year, according to the Commercial Finance Association.
In an economy that has financial institutions clamping down on commercial lending and credit, banks that offer asset-based lending to businesses, hoping to ride out a shaky economy, are becoming more scarce.
This is a reality that worries many small businesses struggling to gain solid footing in an unstable market.
After all, even companies with strong bank relationships can fall out of favor with lenders and lose access to financing, particularly after ending a couple quarters with losses.
Bad short-term results do not necessarily mean that a business is in trouble, but because of underwriting constraints, one tough quarter can prevent these companies from qualifying for additional financing and leave them short on funds.
One of the most effective ways for a business to improve profitability is through the efficient use of cash. If current cash flow is limited, companies must begin their search for alternative ways to start and grow their business. While asset-based lending has had a reputation for being a "last resort" lending option, it has become an attractive option for small businesses with little to no liquidity.
Asset-based lending, by definition, is corporate financing secured with company assets, such as accounts receivable, inventory, equipment or real estate. It focuses primarily on current assets and liabilities and managing them for maximum capital -- whether to grow or replenish resources -- and helps fill the void in cash-flow cycles.
This type of financing allows businesses to:
- take advantage of trade and quantity discounts;
- reduce interest expense by minimizing the use of borrowed funds;
- expand the business without additional equity capital; and
- utilize current assets to facilitate leverage acquisitions, management-led buyouts or employee stock ownership plans.
Due to focusing primarily on a company's assets rather than balance sheet data or cash flow, asset-based lending enables businesses to secure larger credit lines than would otherwise be available. Since asset-based lending is a considerably more labor-intensive type of lending, more banks are opting out, leaving small-business owners with a shrinking number of lending options.
But options do still exist. In many cases, businesses interested in this type of lending should look to smaller, local financial institutions for assistance. When seeking asset-based lending, they should search out lenders that are comfortable with both their business model and their collateral to ensure a smooth relationship and open communication.
Businesses should also be comfortable with the options and terms their lending institution offers. For example, they should look for options like revolving accounts receivable and inventory loans, where funds are advanced based on the value of the company's outstanding receivables and inventory, or fixed-asset financing, when business growth requires capital investments in equipment and real estate.
Asset-based lenders will typically fund businesses with annual sales ranging from $250,000 to more than $1 billion. Credit depends on the type of business and the content and quality of the company's collateral. Frequently, credit granted is more than the net worth of the business.
Asset-based lending also tends to feature fewer payment terms than other types of financing, and the terms it does include tend to be more flexible. Conversely, other types of financing often have multiple conditions covering such things as interest, fixed charge coverage and minimum new worth.
A key feature of asset-based lending is that its availability often increases as the company's working capital increases, so it adapts to a company's needs more effectively than other loans.
Asset-based lending is not necessarily appropriate for every company, and small businesses should consider all types of financing before settling on any one. The cost of asset-based lending varies, usually according to the borrowing company's creditworthiness, and it tends to be a more expensive option.
However, banks with an understanding of what the small business faces in the marketplace will offer comprehensive ABL solutions and competitive financing options to help maintain the health of these businesses.
Sean Hough, a vice president of K Bank's commercial lending division, can be reached at (410) 363-7050.
Posted by dspringer at February 22, 2006 11:31 PM
