Asset-based loans are one of many working capital financial tools available to business owners — and they aren’t just for companies “in trouble.” This might surprise executives of the old guard, who tag the asset-based structure as a Band-Aid for unprofitable companies.
“Some business owners will still think of asset-based loans and lending for the guy that doesn’t have enough equity in his company and doesn’t have enough money,” says Everett Orrick, Orange Country regional manager for Comerica Bank.
Traditionally, asset-based loans have been a fit for business owners in promising turnaround situations, as well as manufacturing operations in growth mode. But these loans can also build in much-needed checks and balances — not to mention some elbowroom when negotiating with the bank. You could eliminate a personal guarantee, secure more credit or even get better pricing on an asset-backed loan as opposed to a traditional line of credit.
Describe how asset-based loans work.
Asset-based loans allow businesses to secure a working capital line of credit with an advanced rate based on assets, including accounts receivables and inventory. For example, if you are a distributor of paper supplies and the bank gives you a $10 million credit line, it will lend you only 80 percent of your accounts receivables on any given day, and 60 percent based on your inventory. You produce a borrowing base certificate for the bank on a daily, weekly or monthly basis, depending on your credit risk. This form lists a number of variables, including accounts receivable and inventory levels. Based on that information, the bank will determine how much it will lend to that business on a given day.
Why are these loans valuable for rapidly growing businesses?
Asset-based loans can help growing companies close the gap between paying vendors to get supplies and collecting accounts receivables from customers. This is especially helpful for those rapidly growing companies in the manufacturing and distribution sectors.
Let’s say the company has high equity and a healthy balance sheet. The company is growing, and every dollar in sales the company adds requires additional working capital. In other words, when that paper supplier takes another order from a customer, it has to pay a vendor to get the supplies so it can fulfill that order. It pays the supplier long before it collects from the customer.
Usually, vendors must be paid immediately or at least within 30 days. Customers probably pay between 60 and 90 days — maybe 30 days if they really rely on your services. With an average 60 days on receivables, that means the company gets paid one month after it pays its suppliers. The more a company sells, the larger the gap between payables and receivables. Asset-based loans can help companies bridge that gap so they can continue to grow and stabilize their cash flow.
Who else is an ideal candidate for an asset-backed loan?
Many businesses benefit from the tighter controls banks enforce when they extend asset-based loans. For example, if you are busy on the sales and marketing side of your business and you want to have more checks and balances on how your financial team manages your assets and liabilities, this type of loan is that check and balance. Your bank won’t lend you more than 80 percent on receivables and an agreed-upon percent on your inventory. That is a control. If your inventory grows too rapidly, the bank will say, ‘You are over-advanced. How will you fix it?’
Also, business owners who overlook asset-based loans miss out on an opportunity to eliminate one thing most everyone dislikes: the personal guarantee on the debt they owe the bank. In return for giving the bank more comfort (because asset-based loans allow them more control and less risk), a lender may consider trading an asset-based structure for that personal guarantee. Or a lender may give you a larger line, but only if you elect an asset-based structure.
What is the difference between an asset-based loan from a bank and a similar arrangement with a factor or finance company?
Those companies really only lend to very highly leveraged businesses or turnaround companies, and they use this asset-based tool. But some finance companies tend to have higher rates and waiver fees. It’s really important not to confuse asset-based loans from banks and finance companies. Banks can provide a similar structure as the finance companies, but the rates and fees are negotiable because banks place high value on the customer relationship.
Many business owners do not realize their banks offer asset-based loans — and many smaller, regional banks don’t have the back-shop support to adequately monitor this structure. Larger financial institutions with a national reach often can support and offer asset-based loans to their customers.
EVERETT ORRICK is Orange Country regional manager for Comerica Bank. Reach him at (714) 435-3900 or [email protected].
