Asset Based Lending Basics for the Business Owner

Lenders like to throw around terms such as ABL, Factoring, C&I lending and other terms to describe the different flavors of working capital lending available to business owners.  Today’s post will try to give an overview of one of thee approaches Asset Based Lending or ABL.  Even ABL has a number of flavors depending on the profile of the business.  ABL is designed to meet the needs of a company that needs working capital financing to bridge financial needs between the time and bill is rendered to the customer and when it is paid.  Generally, ABL facilities lend to the business an amount calculated as a percentage (typically 80{dcbe5b97d7f3b51ccdb48a72cdeba161ba5de4364c5d75cc47e6900cfaa43835}) of so-called eligible receivables.  To be eligible the receivable has to arise from goods actually sold or services actually rendered for which a bill has been issues to the customer and is payable by the customer in accordance with normal business terms (such as 30 days from date of bill etc).  The ABL lender will provide the potential borrower for the limits that the ABL lender will place on eligible receivables.  For example if an invoice is due within 30 days the ABL lender would provide that if it is not paid within 30 days it is no longer eligible.  Same for a customer who files bankruptcy or foreign sales (with some exceptions) or other credit criteria the lender places on eligible receivables.

The ABL lender will advance against a so-called borrowing base.  The borrowing base can be submitted as often as daily but depending on the lender may be required weekly or monthly.  The purpose of the borrowing base is to determine the exact amount of eligible receivables.  Since the lender will not exceed the maximum percentage and maximum loan amount of eligible receivables, if a receivable is no longer eligible it is removed from the borrowing base and if the outstanding loan exceeds the agreed percentage of eligible receivables that portion of the principal would have to be repaid immediately unless the outstanding loan is still less than the agreed percentage of eligible receivables.

For Example–The ABL Lender has agreed to lend the borrower no more than the lesser of $1,000,000 or 80{dcbe5b97d7f3b51ccdb48a72cdeba161ba5de4364c5d75cc47e6900cfaa43835} of eligible receivables.  Assuming a weekly borrowing base–Lets assume in week one that eligible receivables equal $1,000,000. That means the ABL lender would agree to advance (unless there is a default under the loan agreement) up to $800,000 or 80{dcbe5b97d7f3b51ccdb48a72cdeba161ba5de4364c5d75cc47e6900cfaa43835} of eligible receivables to the borrower.  Assume at the end of week 2, the borrower reports that a receivable for $20,000 is beyond it original terms of payment and is no longer eligible.  Assuming no new eligible accounts receivable the amount of eligible accounts would decrease to $980,000 and the total amount the ABL lender will lend would be 80{dcbe5b97d7f3b51ccdb48a72cdeba161ba5de4364c5d75cc47e6900cfaa43835} of the now total of eligible receivable or $784,000.  If the outstanding loan is $800,000 the borrow will have to pay immediately $16,000 of principal to the ABL Lender.

Generally, the borrower will generate new eligible receivables and everything balances out, but ABL lenders do not like to allow so-called overadvances that cause the outstanding loan to exceed the up dated borrowing base.

Another traditional way that ABL lenders help borrowers to keep costs down is to provide that all collections of accounts receivable of the borrower be paid into a lock box with the lender. Traditionally, this is a PO Box controlled by the ABL lender that is put on all of the invoices of the borrower so that all payments from customers go to the box and are applied by the ABL Lender to the loan.  This will give the borrower additional availability under the loan and keep interest (which has to be paid monthly to the ABL Lender) a little lower since the principal outstanding is reduced more frequently.

The real strength of traditional ABL lending is that the ABL lender will generally not only look to the financial health of the borrower but more importantly the financial health the customers of the borrower.  A small to mid-sized business selling to AAA rated credits may find financing at a lower cost due to its customers credit rating.  Also a borrower that has struggled financially but is now selling and collecting from the same AAA credit may be able to get financing that would not be support solely on the balance sheet of the borrower.

The cost in terms of interest and fees for ABL lending varies from just an interest charge comparable to any bank loan to a finance company charging a great deal over bank rates and assessing fees for examination of the borrowers receivables and financials and even termination fees.  The stronger the financial condition of the borrower the more likely that the cost of ABL lending will be less.

Clearly ABL Lending requires a borrower who is selling a product or service and has a track record of collecting from its customers as well as no serious financial problems.  Start-ups and most small companies will not be able to look to ABL lending as a source of working capital finance.  Companies with very strong balance sheets also may want to avoid the additional costs of examination and processing fees related to ABL Lenders.  However, for the middle market company with an established track record of customers or even a company coming out of downturn but with a strong customer base, ABL lending may be a solution to the need for working capital as receivables collect out.