Business owners have felt the squeeze of volatile credit markets and may have put off critical projects and growth plans. But some may not be aware of a thriving lending source that can benefit asset-rich companies, Asset-Based loans. This is an option many companies from small to middle-market and large corporations, public and private are considering. In fact, according to the Commercial Finance Association most recent Quarterly Asset Based Lending Index for the 2nd Quarter of 2011, the 20 largest asset-based lenders saw a sharp increase in the demand for new credit by U.S. businesses.

Unlike lenders who primarily consider cash flow or credit, asset-based lenders (ABLs) consider a variety of assets to determine qualifications in obtaining a loan. Depending on the loan structure, a company’s eligible assets can become as good as currency.

Determining the Base
The first step is developing the borrowing base and working together with the lender to establish a financing amount. The borrowing base is determined by the revolving lines of credit offered by the asset-based loan – in some cases up to 85% of a businesses’ accounts receivable and up to 65% of the value of eligible inventory. Depending on the financing need and liquidation value, borrowers with highly marketable inventory such as raw materials and finished goods can work with lenders to structure an asset based loan to fit a variety of needs. Even a company’s intangible assets, such as patents, trademarks, and copyright can contribute to the company value estimate.

Key Calculations
Calculating the borrowing base can be a rigorous process. Financial covenants may be established and can vary depending on accessible liquidity.

Should a lender impose a financial covenant, they will typically make use of the fixed charge coverage ratio to determine if the cash flow the borrower generates is enough to cover fixed expenses, such as interest and leases. Nevertheless, innovative lenders can work with borrowers to structure financial covenants that allow companies to proceed with an established business plan that includes acquisition, expansion, investment, or even share buy-backs and dividend distributions.

This process requires active company participation. By letting an independent appraiser value collateral assets and inventory, and allowing lenders to review financial documents, borrowers can determine their borrowing base and effectively support business operations.

In short, asset-based lending works this way: When a business collects (cash) payment from customers, they reduce loans and accounts receivable. The business borrower will then request for an advance when they need to pay for inventory. Out of the asset-based loan, cash will flow into the business.

Key Advantages
There are several advantages to asset based loans:

Cash Flow: Asset-based loans present an opportunity to gain access to credit where cash-flow based options could be limiting or unfeasible because of current economic conditions. In addition, asset-based loans are more adaptable to a changing economy, and more reliably resilient in terms of asset-value fluctuations.

Flexibility: Moreover, the provisions in an asset-based loan agreement are often less strict than if cash-flow were the basis. Asset-based loans can also provide a business owner to the flexibility to pursue business growth initiatives.

Interest Spread: Another advantage of an asset-based loan is its relatively lower interest spread compared to a cash-flow-based credit. Since lenders consistently analyze the value of the collateral assets and the resulting borrowing base, they can more confidently project the risks associated with the loan.

Asset based loans are an option that can suit a variety of companies from manufacturing, distribution, and retail businesses to service-based businesses that need working capital financing. It is a tool that has grown from a mostly small-business financing option to include middle-market and large corporations, public and private.

By Terry Stidham, Senior Vice President, Managing Director of The March Group.