Asset-based lending utilizes the same criteria as banks but with one critical difference. Asset-based lenders (ABLs) focus on the quality of the asset (such as trade accounts receivable or inventory) being offered as collateral first and the company’s financial performance and strength second.
In fact, ABLs often look past one or two years of poor financial performances and are more comfortable with weak balance sheets because they understand that businesses sometimes experience problems (look no further than the 2009 recession and its impact on businesses). However, similar to banks, the need for sound collateral, solid secondary repayment support, and a well-developed business plan are essential to secure a loan.
But ABLs have a hidden benefit that a business should exploit when appropriate: ABLs may extend higher borrowing levels against certain assets than banks. For example, banks tend to be more conservative and may advance only 75 percent against eligible trade accounts receivable, so if you have $1 million of eligible trade receivables, you can borrow a maximum of $750,000.
If the collateral strength of the trade receivables is strong, an ABL may lend 80 or even 85 percent against the eligible trade receivables, which would allow you to borrow $800,000 to $850,000. The additional borrowing availability may not seem like much, but when cash is tight, having extra dollars of liquidity is invaluable.
So, you may ask, why not skip the bank and simply secure financing from an ABL? Well, ABL lending is more expensive. From the interest rates charged on the loans to the fees assessed to manage the relationship, the cost of ABL-provided financing is much higher than with traditional banks. Keep in mind, however, that an ABL absorbs additional risks with weaker companies and thus requires a higher rate of return.
Another downside of an ABL is that you need to be prepared to implement much tighter management reporting requirements than you would with a bank. Whereas a bank may require monthly reports and information, ABLs often look for weekly or, in some cases, daily reporting procedures to be implemented to properly track and manage the assets they’re lending against.