Asset-Based Lending

Introduction

What is Asset-Based Lending (ABL)?

• A form of secured financing where borrowing capacity is determined by the value of specific collateral assets
• Rather than enterprise cash flow or creditworthiness

Introduction

What is Asset-Based Lending (ABL)?

• The borrowing base—the amount available to draw—fluctuates based on eligible:
• Accounts receivable, inventory, equipment, and sometimes real estate values
• Lenders advance percentages against each asset category

Key Characteristics

Collateral-Driven:

• Borrowing availability determined by applying advance rates to eligible asset values
• Rather than leverage ratios or EBITDA multiples
• Creating dynamic borrowing bases adjusting with asset fluctuations

Key Characteristics

Revolving Structure:

• Borrowers can draw, repay, and redraw funds as needed
• Within the borrowing base
• Similar to traditional revolving credit but with availability tied directly to collateral values

Key Characteristics

Over-Collateralization:

• Lenders advance only percentages of asset values
• E.g., 85% of receivables, 50% of inventory
• Creating cushions protecting against collateral value declines, collection delays, or liquidation discounts

Key Characteristics

Active Monitoring:

• Regular borrowing base certificates (typically monthly or weekly)
• Field examinations, inventory counts, and accounts receivable audits
• Ensure ongoing collateral valuation accuracy

Key Characteristics

Lower Credit Requirements:

• Asset coverage focus enables lending to companies with:
• Weak credit profiles, limited operating history
• Or financial stress that would preclude traditional cash flow-based financing

Key Characteristics

Higher Advance Rates:

• Compared to traditional working capital facilities
• ABL often provides greater liquidity against current assets
• With borrowing bases potentially exceeding what leverage-based facilities would permit

Structure and Components

Borrowing Base Formula:

• Specific percentages applied to eligible asset categories
• Typically including 85% of eligible accounts receivable
• 50-65% of eligible inventory, and 60-80% of equipment appraised orderly liquidation value

Structure and Components

Eligibility Criteria:

• Detailed definitions determine which assets qualify for the borrowing base
• Excluding aged receivables (typically over 90 days), slow-paying customers
• Inventory deemed obsolete, and assets not meeting quality standards

Structure and Components

Advance Rates:

• Percentages reflect asset quality, liquidation timeframes
• Industry norms, and lender risk appetite
• Varying significantly across industries and individual credits

Structure and Components

Reserves:

• Lenders establish reserves reducing availability for identified risks
• Including rent obligations, customer deposits
• Dilution (credits and returns), and other potential claims against collateral

Structure and Components

Facility Size:

• ABL lines typically range from $5 million to over $500 million
• With size determined by aggregate borrowing base
• Rather than leverage multiples or coverage ratios

Structure and Components

Minimum Availability:

• Covenants typically require maintaining minimum unused availability
• Often $1-5 million or 10% of commitments
• Ensuring liquidity cushions during operational stress

Structure and Components

Interest Rates:

• Pricing typically includes SOFR plus margins ranging from 200 to 400 basis points
• Depending on credit quality, advance rates, and monitoring requirements
• Generally higher than traditional cash flow facilities

Eligible Collateral Categories

Accounts Receivable:

• Trade receivables from customers typically represent the highest quality collateral
• With advance rates of 80-90% on eligible balances
• Eligibility excludes foreign receivables (sometimes), aged amounts, affiliate balances, disputed invoices

Eligible Collateral Categories

Inventory:

• Raw materials, work-in-process, and finished goods
• Receive advance rates of 40-65% depending on turnover, obsolescence risk, and liquidation value
• Retailers often receive higher rates on finished goods than manufacturers on work-in-process

Eligible Collateral Categories

Equipment:

• Machinery, vehicles, and other equipment may be included
• At 60-80% of orderly liquidation value
• Based on independent appraisals, providing supplemental availability beyond current assets

Eligible Collateral Categories

Real Estate:

• Some ABL facilities include owned real estate at 60-75% of appraised value
• Though this varies significantly based on property type, location, and marketability

Eligible Collateral Categories

Intellectual Property:

• Patents, trademarks, and other IP rarely included in traditional ABL
• But may provide value in specialized situations
• With established licensing revenue or clear liquidation markets

Borrowing Base Mechanics

Calculation Frequency:

• Borrowers submit borrowing base certificates monthly (for stable businesses)
• Or weekly (for volatile or stressed situations)
• Detailing eligible assets and calculating availability

Borrowing Base Mechanics

Ineligibles and Reserves:

• Deductions for ineligible receivables (aged, foreign, disputed)
• Inventory (obsolete, slow-moving), dilution reserves
• And other lender-identified risks reduce gross asset values to net availability

Borrowing Base Mechanics

Seasonal Fluctuations:

• Borrowing bases naturally expand during peak seasons
• When receivables and inventory grow
• Then contract during slow periods, aligning credit availability with business cycles

Borrowing Base Mechanics

Overadvances:

• Temporary allowances permitting borrowing above the calculated base
• For specific purposes or brief periods
• Providing flexibility during transitions while maintaining overall collateral coverage

Borrowing Base Mechanics

Dominion and Lockbox:

• Lenders often control cash receipts through lockbox arrangements
• Applying collections to reduce outstanding borrowings
• And ensuring continuous collateralization

Comparison with Cash Flow Lending

ABL vs. Traditional Revolver:

• Traditional facilities base availability on leverage ratios and financial covenants
• While ABL ties availability to collateral values
• Often providing greater liquidity for asset-rich, cash-flow-challenged companies

Comparison with Cash Flow Lending

ABL vs. Term Loans:

• Term loans provide fixed amounts amortizing over time based on cash flow projections
• While ABL provides flexible revolving access
• Based on current asset positions

Comparison with Cash Flow Lending

Covenant Differences:

• ABL focuses on collateral coverage and minimum availability
• Rather than leverage ratios or fixed charge coverage
• Though may include springing financial covenants when availability falls below thresholds

Comparison with Cash Flow Lending

Monitoring Intensity:

• ABL requires significantly more intensive monitoring
• Field exams, inventory counts, receivable audits
• Compared to traditional cash flow facilities relying primarily on financial statements

Comparison with Cash Flow Lending

Use Cases:

• ABL suits asset-intensive businesses with variable cash flows
• Companies in transition or turnaround
• While cash flow lending suits stable businesses with predictable earnings

Role in Capital Structure

Working Capital Management:

• Primary use provides revolving liquidity funding day-to-day operations
• Supporting accounts receivable and inventory cycles
• Without requiring permanent capital deployment

Role in Capital Structure

Seasonal Financing:

• Enables businesses with pronounced seasonal patterns
• To increase borrowings during inventory build periods
• And reduce them during collection cycles, matching financing to needs

Role in Capital Structure

Turnaround Situations:

• Companies in operational or financial transition use ABL to maintain liquidity
• When traditional lenders exit
• Supporting stabilization efforts while implementing improvement plans

Role in Capital Structure

Acquisition Financing:

• Provides working capital component in acquisition structures
• Often alongside term debt
• Ensuring targets have sufficient operating liquidity post-transaction

Role in Capital Structure

Bridge Financing:

• Temporary ABL facilities support companies between permanent financing arrangements
• During restructurings
• Or while building credit profiles for traditional lending access

Advantages for Borrowers

Greater Availability:

• Asset-based approach often provides more liquidity than leverage-based facilities
• Particularly for companies with substantial working capital
• But limited EBITDA or unstable earnings

Advantages for Borrowers

Flexibility:

• Revolving structure accommodates seasonal fluctuations, business volatility
• And changing liquidity needs
• Without requiring amendments or commitment increases

Advantages for Borrowers

Less Restrictive Covenants:

• Focus on collateral coverage rather than financial performance ratios
• Provides operational flexibility
• During business cycles or transitions

Advantages for Borrowers

Credit Profile Tolerance:

• Enables financing for companies unable to access traditional lending
• Due to limited operating history, recent losses
• Ownership changes, or other credit limitations

Advantages for Borrowers

Growth Support:

• Borrowing bases grow automatically as receivables and inventory increase
• Providing self-scaling financing supporting business expansion
• Without requiring facility upsizes

Advantages for Borrowers

Acquisition Enablement:

• Acquired company assets immediately available in borrowing base calculations
• Facilitating add-on acquisitions
• And supporting buy-and-build strategies

Advantages for Lenders

Collateral Protection:

• Direct liens on liquid assets with regular monitoring
• Create strong downside protection
• Historically producing higher recovery rates than unsecured or cash-flow-based lending

Advantages for Lenders

Daily Oversight:

• Continuous monitoring through lockbox control, borrowing base certificates
• And field examinations
• Provides early warning of deterioration and enables proactive responses

Advantages for Lenders

Self-Liquidating:

• Accounts receivable convert to cash through normal collection cycles
• Automatically reducing exposure as business operations continue
• Unlike term debt requiring refinancing

Advantages for Lenders

Relationship Depth:

• Intensive monitoring and servicing requirements create deep client relationships
• Generating cross-selling opportunities
• And producing sticky borrower relationships

Advantages for Lenders

Specialized Expertise:

• Technical complexity and monitoring intensity create competitive advantages
• For specialized ABL lenders
• Limiting competition and supporting pricing discipline

Monitoring and Reporting

Borrowing Base Certificates:

• Regular submissions (monthly or weekly) detail eligible assets
• Calculate availability, and demonstrate collateral compliance
• Supported by aging reports and inventory listings

Monitoring and Reporting

Field Examinations:

• Periodic on-site reviews (typically annually or semi-annually)
• Verify collateral existence, validate accounting practices
• Assess operations, and confirm borrowing base accuracy

Monitoring and Reporting

Inventory Counts:

• Physical verification of inventory quantities and conditions
• Either through lender-conducted counts
• Or observation of client perpetual inventory systems

Monitoring and Reporting

Receivable Audits:

• Confirmation of receivable existence and terms through direct customer contact
• Testing payment patterns
• And validating invoice accuracy and shipping documentation

Monitoring and Reporting

Financial Reporting:

• Monthly or quarterly financial statements, aging reports, inventory reports
• And compliance certificates
• Maintain lender visibility into business performance and collateral quality

Covenants and Terms

Minimum Availability:

• Requirements to maintain unused capacity
• Typically $1-5 million or 10% of commitments
• Ensure liquidity cushions and trigger enhanced monitoring or remedial actions

Covenants and Terms

Springing Financial Covenants:

• Fixed charge coverage ratios or minimum EBITDA requirements
• That activate only when availability falls below specified thresholds
• Typically 10-15% of commitments

Covenants and Terms

Permitted Debt and Liens:

• Restrictions on incurring additional secured debt
• That might dilute ABL collateral position
• Or create competing claims on assets

Covenants and Terms

Asset Sales and Distributions:

• Limitations on asset dispositions outside ordinary course
• And restrictions on dividends or distributions
• Particularly when availability tightens

Covenants and Terms

Change of Control:

• Provisions requiring lender consent or triggering repayment obligations
• Upon ownership changes
• Protecting against adverse credit implications

Industry Applications

Manufacturing and Distribution:

• Companies with significant receivables and inventory use ABL
• To fund working capital cycles, manage seasonal patterns
• And support growth initiatives

Industry Applications

Retail:

• Seasonal inventory requirements, particularly for holiday periods
• Create natural ABL applications
• With borrowing bases expanding during inventory builds and contracting post-season

Industry Applications

Healthcare:

• Medical practices, hospitals, and healthcare service providers
• Leverage patient receivables and equipment
• Though government payor concentration requires specialized structuring

Industry Applications

Transportation and Logistics:

• Trucking companies and logistics providers use ABL
• Against receivables and vehicle fleets
• Supporting working capital and equipment acquisition

Industry Applications

Wholesale and Import/Export:

• Trade finance applications where inventory in transit
• Letters of credit, and international receivables
• Require specialized ABL expertise and structuring

Risk Considerations

Collateral Concentration:

• High concentrations in specific customers, product lines, or geographic regions
• Create vulnerability to individual failures
• Or regional economic downturns affecting multiple collateral components

Risk Considerations

Fraud Risk:

• Aggressive accounting, fictitious receivables, or inventory manipulation
• Can inflate borrowing bases
• Requiring robust monitoring procedures and strong controls

Risk Considerations

Liquidation Value Volatility:

• Asset values can decline rapidly during industry downturns
• Inventory obsolescence, or customer financial stress
• Potentially creating borrowing base deficiencies

Risk Considerations

Operational Complexity:

• Maintaining accurate borrowing base calculations
• Coordinating with lockbox arrangements
• And managing intensive reporting requirements demands sophisticated financial operations

Risk Considerations

Advance Rate Pressure:

• Lenders may reduce advance rates or tighten eligibility criteria during stress
• Reducing availability
• When companies most need liquidity

Risk Considerations

Recovery Timing:

• While collateral provides security
• Converting assets to cash through liquidation takes time
• And may realize values below advance rates, particularly in distressed sales

Pricing and Fees

Interest Margins:

• Spreads over SOFR typically range from 200 to 400 basis points
• Depending on credit quality, advance rates, collateral composition
• And monitoring intensity requirements

Pricing and Fees

Unused Line Fees:

• Charges on undrawn commitments, typically 25-50 basis points annually
• Compensate lenders for capital availability
• And facility maintenance

Pricing and Fees

Closing Fees:

• Upfront fees of 0.5-1.5%
• Cover due diligence, documentation, and arrangement efforts
• Paid at facility closing

Pricing and Fees

Field Examination Fees:

• Borrowers reimburse costs of field exams, appraisals, and inventory counts
• Typically $10,000-50,000 per examination
• Depending on scope and complexity

Pricing and Fees

Administrative Fees:

• Annual or monthly fees compensating for borrowing base monitoring
• Reporting review
• And ongoing facility administration

Pricing and Fees

Early Termination Penalties:

• Some facilities include prepayment fees or minimum revenue commitments
• Protecting lender returns
• From premature refinancings

Intercreditor Considerations

First Lien/Second Lien Dynamics:

• ABL typically holds first priority liens on current assets
• (receivables, inventory)
• While term lenders hold first liens on fixed assets and intellectual property

Intercreditor Considerations

Carve-Outs and Exceptions:

• Priority agreements defining which lender receives proceeds
• From specific asset categories
• Governing enforcement rights and payment waterfalls

Intercreditor Considerations

Standstill Provisions:

• Term lenders often agree to standstill periods
• Allowing ABL lenders to control initial enforcement on current assets
• Before term lenders can exercise remedies

Intercreditor Considerations

FILO Structures:

• First-in-last-out arrangements where portions of ABL facilities
• Subordinate to main ABL tranche but maintain priority over term debt
• Creating blended risk-return profiles

Conclusion

• Asset-based lending provides essential liquidity for companies with substantial tangible assets
• Requiring flexible financing that traditional cash flow-based facilities cannot efficiently provide

Conclusion

• By focusing on collateral values rather than earnings metrics
• ABL supports businesses across their lifecycle
• From growth companies building working capital to mature companies managing seasonal fluctuations to distressed situations

Conclusion

• The intensive monitoring and collateral focus create downside protection
• Enabling lending where traditional facilities cannot
• While the revolving structure provides flexibility matching borrower needs

Conclusion

• For lenders, ABL combines specialized expertise, deep client relationships
• And strong collateral protection into attractive risk-adjusted returns

Conclusion

• Success with ABL requires sophisticated understanding of collateral liquidation dynamics
• Industry-specific asset characteristics, and operational discipline
• To maintain accurate borrowing base calculations and monitoring