As owners of small businesses know, the process of securing capital is not always straightforward. Bank-loan regulations often prove too restrictive for many small businesses (whether they be startups, turnarounds/reorganizations, seasonal sellers, or companies experiencing different stages of growth). As these organizations search for ways to thrive in an increasingly competitive landscape and find solutions for immediate working-capital needs, more and more lower-middle market businesses are turning to alternative financing options, such as asset-based lending (ABL).
What Is Asset-Based Lending?
Asset-based lending (ABL) is a revolving line of credit based on a business’s accounts receivable, inventory or other approved collateral. ABL lenders typically underwrite the collateral first before a company’s financial statements, and therefore can provide capital for those scenarios that banks may choose to decline.
The fundamental issue that ABL solves is cash flow. According to a recent Small Business Credit survey, “22% of employer firms say managing cash flow is their top business challenge, above business costs and far above government regulations and taxes.” It’s a very simple formula: If cash doesn’t flow, businesses can’t grow. According to the report,“47% of firms applied for credit in the past 12 months, with the top two reasons for borrowing to expand the business or to meet operating expenses (i.e., cash flow).”
Asset-based lenders act as a financial partner by providing senior secured debt with advance rates of up to 85 percent (more in some cases) against commercial accounts receivable, and up to 50 percent against raw and finished goods inventory (in many cases, even more). ABL providers frequently offer no-covenant options, and personal guarantees are typically not required.
Advantages of ABL
Because ABL lenders are focused on the collateral as opposed to the condition of the balance sheet and/or profits and losses, they can also provide greater flexibility and liquidity than banks — whose loans are highly regulated and often require a company to be in pristine financial condition.
Senior-secured ABL revolving lines of credit may range, for example, from $500,000 to $10 million for companies with a target revenue range between, say, $3 million and $100 million. This collateral-driven borrowing capacity can even work for companies with limited operating history, negative cash flow, or lack of tangible net worth. All ABL requires is acceptable collateral such as accounts receivable, inventory, or machinery and equipment. It works during transitions of any kind, acquisitions, bank refinancing, recapitalization or growth periods, and can start at any stage of turnaround (or financial recovery), including DIP (debtor-in-possession) and exit financing.
Why Do Businesses Use ABL?
Free up debt capacity:
Gibraltar recently completed a $12 million revolving credit facility for a distributor of lumber and other building products. The business had seen strong sustained sales growth, creating a need for expanded credit. This custom solution included increased advance rates on accounts receivable and inventory, all designed to free up additional debt capacity to meet growing working-capital needs. Recently, Gibraltar increased their line to $16 million to further support the growth and direction of this business.
As consolidation and growth in the healthcare industry continues, the industry is seeing tremendous growth and an increasing need for ABL working capital. Recently, Gibraltar established a $2.5 million revolving line of credit to support the national expansion of a Denver-based healthcare provider of on-demand rentals of durable medical equipment and respiratory equipment.
Replace existing credit line:
For example, an energy company that designs, manufactures, and installs solar photovoltaic inverters needed to replace its existing $2.5 million credit line. The company partnered with Gibraltar for a $4 million ABL structure designed to provide the additional capital needed for the company’s continued growth.
Fill in seasonable gaps:
Seasonality can create serious cash-flow issues for many businesses, where companies need working capital during their off-season, while gearing up toward their peak seasons of sales.
Support a turnaround:
Companies looking to bounce back from a period of decline or in the midst of a restructuring often look to ABL. Gibraltar provided a $6 million accounts receivable/inventory revolving line of credit to an east coast food manufacturer owned by a private equity group. After losing a major customer, the company was under pressure from their existing bank lender to find a new capital provider. An ABL revolving line of credit provided more capital than the bank was willing to lend, allowing the business to right size their inventory and get their revenue ahead of schedule.