One of the most frequently asked questions we receive is, “How is an asset-based loan different from a traditional banking alternative?” Each time this question is asked, we realize that a large part of what we do is educate prospects, internal partners, and the general market about our products. Keeping people properly informed about the benefits of an asset-based credit facility — despite its existence for decades — remains an important part of achieving our goals.
Asset-based lending is often thought of as an option in distressed situations, or for more highly leveraged companies that might be going through a merger, acquisition, or period of high growth. Simply put, if the traditional bank says, “no”, that’s when it’s time to call an asset-based lender. Moreover, a lot of companies that would qualify for traditional bank financing choose an asset-based solution due to the flexibility that it offers.
If companies qualify for a traditional bank loan and have plenty of financing options, why would they choose an asset-based credit facility? Here are some of the main differences between asset-based and traditional bank alternatives.
More focus on asset values — While asset-based lenders tend to focus on a company’s ability to cash flow, the first step is typically to get a solid understanding of its assets. The level of cash flow and asset coverage usually drive the type of credit facility that will be a good fit. If cash flow is negative but there is an abundance of collateral and a justifiable story, an asset-based solution is often a better solution. If cash flow is strong but asset coverage is not quite adequate to cover the desired loan amount, a traditional bank or leveraged cash flow option may be better, although a stretch piece for an asset-based lender may be justified to help offset some or all of the higher debt often offered from a cash flow option. If there is decent asset coverage and adequate, although not abundant, cash flow (many opportunities fit in this category), an asset-based option should be considered in conjunction with a traditional cash flow option. In working-capital-intensive and asset-heavy businesses, an asset-based option can work especially well.
Less focus on balance sheet leverage and debt/EBITDA levels — While we may keep these basic benchmarks in mind, asset-based lenders rarely require a balance sheet or debt to EBITDA covenant.
Fewer financial covenants in general — Due to the fact that asset-based lenders take some comfort in having adequate asset coverage, they are typically more measured in their approach to working through business cycles. Using one covenant (fixed charge coverage) or springing covenants is fairly common.
Less reliance on personal guarantees — Because of the heavier reliance on the underlying assets of a business, personal guarantees are typically required much less frequently in an asset-based solution than in a traditional bank solution.
Potentially higher advance rates — Depending on the situation, an asset-based lender can often offer higher advance rates than a traditional bank alternative. That said, if a bank has been overly aggressive and has ignored items that should be considered ineligible for borrowing (past due accounts receivable, slow-moving inventory, etc.), the opposite can be true, which can introduce challenges to presenting a viable lending alternative.
Fewer relationships per relationship manager — Typically, our relationship managers manage eight to 10 accounts, often allowing for a higher level of service than that offered by many traditional lending options.
Longer term solution — Most asset-based lending alternatives offer a three- to five-year term as opposed to a one-year term offered by many traditional banks. This can allow a company to take advantage of today’s attractive market conditions for a longer time.
What’s the catch?
In exchange for increased flexibility, asset-based lenders typically monitor the performance of a company more closely through increased frequency of financial reporting frequency (often monthly or weekly for some information), collateral exams (typically 2-3 times per year), and dominion of cash through the use of a lockbox (triggers to spring the use of a lockbox are not uncommon, and most companies use a lockbox in any event). Depending on the situation, the complexity of the legal documentation process can also differ. In many cases, borrowers already generate most of the reports an asset-based lender may request. In addition, many borrowers come to appreciate the disciplines introduced by an asset-based facility.