Asset-based advantage

Give your company a financing edge by considering asset-based lending. It’s underused in Canada but has the potential to help smaller companies

By Mike Oskroba

A growing company has plenty of orders for its products — in fact, too many. It has to pay for components and supplies on net 30-day terms, while some of its own customers are slow paying their bills. The company is reluctant to turn down new business and is developing a serious shortage of cash. It’s wildly successful but finds itself unable to pay its own suppliers.

Another company has secured a major new contract, but needs money to invest in new production equipment. It’s already bumping the ceiling on its revolving loan and the bank is unwilling to take further exposure.

A third company is going through a dip in sales, yet still has a good base of steady customers. It needs cash to cover rent, payroll and other fixed costs until the sales cycle improves.

In all of these cases, there’s a pressing need for working capital, but finding it may be difficult.

One solution to consider is asset-based lending (ABL). While traditional lenders, such as banks, will focus on a company’s financial statements, references, and credit history to determine its credit-worthiness, asset-based lenders usually finance on the strength of a company’s assets. These assets may include the company’s accounts receivable, inventory, equipment or real estate. Lenders rely on these assets as collateral to recoup their capital in the event of default and bankruptcy.

In Canada, ABL represents only about 5% of all commercial loans. In the U.S. it accounts for more than 50%. Chances are this discrepancy is due to a lack of an understanding by Canadian companies of the more flexible nature of this financing solution.

There are three main strengths in the ABL model: availability, speed, and knowledgeable lenders. 

Availability. If a company can’t get financing by any other means and the need for working capital is acute, the issue becomes not a matter of a few basis points difference on a loan, but rather whether it can get financing at all. Some customers find that they initially negotiated a credit instrument based on certain covenants involving debt-equity ratios and other calculations. They then discover that they no longer meet the bank’s criteria, and access to cash is cut off — right when it’s needed most. What may be a deal-breaker for a traditional bank may be only a warning sign to an asset-based lender.  In addition, asset-based lenders will provide you with higher advance rates than a traditional bank against your accounts receivable, inventory, machinery and equipment.   

Speed. Asset-based lenders are generally very prompt responding to requests. Since they tend to specialize in specific market niches and product types, they can quickly size up the situation and advise if your company is a likely candidate for their financing product. If they are interested in proceeding, they will issue a term sheet in short order. Usually within a week or two after the terms are accepted, they begin due diligence and conduct an on-site audit. The entire process typically takes about 90 days depending on the preparedness of the prospective company, the audit results, the credit approval process, and the documentation of the legal aspects of the transaction.

Knowledgeable vendors. If you can find an asset-based lender that specializes in your industry, you may not have to spend much time educating its personnel about your business. These lenders may be able to examine your company and find opportunities to extend credit that you may not have considered.

Finding the right asset-based lender

Because some asset-based lenders are specialists and may not like to work outside of their comfort zone, you need to find the right lender for you. If you can fit into their focus by industry type, size of company, amount of loan, type of asset and other considerations, you are more likely to get the financing that is right for your business. Accountants, lawyers, brokers and investment bankers are a good source for contacts and tend to know who’s in the marketplace for the type of financing you need.  

When working with any lender, it pays to develop the relationship before you need it.

You may need to educate the lender about your business. This takes time, and when you need financing, you may not have that luxury. Develop an information package that covers the following:

• The flow of your receivables, which may be seasonal or cyclical;
• The quality of your receivables, including aging trends and the payment history of each customer;
• Your invoicing and collection policies;
• The experience and other qualifications of your management team, including biographical information;
• Lists of inventory by type, location, and classification (i.e. raw materials, work-in-process or finished goods);
• Recent appraisals on inventory, machinery and equipment, and real estate;
• Financial statements for the last three fiscal year-ends;
• Year-to-date interim financial statements for the most recent period and for the same period last year; and
• A business plan covering projections for the next two years.

Have this information ready to provide to a lender and keep it up-to-date. You will be in a better position when it comes time to ask for a loan.

Even better, contact potential lenders and establish a relationship proactively. If you’re on their Rolodex already, you’ll have a better chance of getting a speedy “yes” when you need financing.

Continuing the relationship

Once you have your financing in place, you may be tempted to file it under “F” for “Forget.” I suggest “A” for “Active.” This is because, as far as the lender is concerned, it’s not the end of the deal when a loan is extended, it’s the beginning.

The lender has likely made agreements with you in which you must provide specific financial information on a regular basis. This information may range from financial statements on a monthly, quarterly and annual basis to an updated status report on the loan’s collateral. You and your financial team should be in regular contact with the lender so that they are aware of your changing financial situation.

Failing to keep the lender informed might cause a loss of goodwill, and you need that goodwill for both current and future deals. They will not be impressed with your forthrightness or your management skills if they learn about significant problems at your company via the rumour mill or the news media.

Asset-based lending is a valuable part of the financing market. A company that learns how to use ABL effectively has a strong advantage, particularly in turbulent times.

Michael A. Oskroba (moskroba@textronfinancial.com) is senior director of business development with Textron Financial Canada Limited.

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