What are the differences between ABL and middle-market?
One big difference between ABL and middle-market lending is cash dominion versus non-cash dominion. ABL structures require cash dominion. That means there is a controlled account agreement and the receipts of a company’s receivables come into a lockbox. Then the funds flow from the lockbox and are used to pay down the revolving debt. The bank essentially has control of the cash, which is a traditional fundamental aspect of asset-based lending.
Another big difference is that asset-based lending groups are more comfortable with leverage. They are not as leverage-focused as the traditional cash flow structure when you get above three times the ratio of debt to EBITDA. Asset-based groups don’t focus on this leverage ratio because they are comfortable within the assets. ABL groups are collateral focused, not leverage focused.
ABL is also a more patient financing solution. For companies in cyclical industries, ABL groups will work with them and be more patient than the traditional cash flow structure, as long as they stay within the assets and have sufficient liquidity.
Asset-based lending is a longer-term commitment. ABL deals are three-year commitments; traditional middle market deals are one- to two-year commitments.
The longer deal provides more certainty to the borrower. Also, it’s very time-consuming to restructure your deal every year or two. If you have a three-year deal, at the maximum you are only doing this every two years. Basically, a long-term deal gives you more certainty and less work.
What challenges do companies in cyclical industries face under traditional lending?
Cyclical industries have up and down periods. When they hit more difficult times and their leverage ratios get to be high, the bank may become uncomfortable with that structure — even if they are within their assets. They don’t have the monitoring that asset-based lending groups provide, so they need to be tighter on the leverage ratio. Traditional lending models might require the owner to sell assets or put cash equity into the business in some form to reduce leverage and debt.
What is involved in the monitoring process?
The borrower typically provides a monthly borrowing base certificate, which details their collateral and their revolving debt position. Then, they generally provide weekly (and sometimes daily) updates and roll forwards of accounts receivable. The bank will want to see quarterly or monthly financial statements as well as annual reviewed or audited financial statements.
How are covenants and the necessity of personal guarantees determined?
Typically, a cash flow structure may have three or four financial covenants, and an ABL structure will have only one financial covenant. Asset-based lenders are comfortable within the assets and the ongoing collateral monitoring. There is more reporting that is required with an asset-based structure, but the benefit is more availability, less financial covenants, and potentially no personal guarantee. If the bank is comfortable with the monitoring of the assets and the collateral it is advancing against, then it probably won’t require a personal guarantee.
Doug Winget is senior vice president, head of asset-based lending and floorplan lending at FirstMerit Bank. Reach him at (330) 384-7448 or [email protected].
