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What Is ABL?
What is Asset-Based Lending?
Asset-based
financial services organizations (asset-based
lenders) play a vital part in financing the
economy and are dedicated to the growth and
well-being of their clients. They provide their
clients with cash by lending on fixed assets,
accounts receivable and inventory, and engage
in factoring, purchase order financing, real
estate financing and leasing. They include
the asset-based lending arms of domestic and
foreign commercial banks, small and large independent
finance companies, floor plan financing organizations,
factoring organizations and financing subsidiaries
of major industrial corporations.
Expert in
all facets of collateralized lending, asset-based
lenders – large and
small alike – possess the experience and
know-how to structure the proper financing
program for their borrowers. They specialize
in financing businesses and business transactions
involving a broad range of products and services,
both domestically and internationally. They
provide:
Operating cash
Funding for an acquisition, a merger or a leveraged buyout
Debt consolidation
Turnaround financing
Bankruptcy/reorganization financing
Equipment financing
Inventory financing
Floor plan financing
Equipment leasing
Import/export trade financing
Growth financing
Factoring services
Growth Money
Businesses need money to grow. A business cannot survive just because it has
a better product, an exclusive market or the best method of distribution.
The catalyst required for progress is money.
Business owners and managers
must be knowledgeable about financing, what
it can do, why one form may be better than
another. It can be used when:
Operating cash is tied up in receivables
The best trade terms for supplies create cash flow shortages
Inventory levels are high because of client demands
Sales growth is straining resources
Seasonality peaks cause problems
No fixed assets are available for collateral
Trade discounts and special pricing terms cannot be obtained
Letters of credit are required to supply or buy overseas
Debtor-in-possession financing is required
Asset-based lenders often advance
funds when traditional sources are not available.
They are familiar with various types of businesses
and are responsive to client needs.
Loan size
Asset-based lenders fund businesses with annual sales less than $250,000 to
more than $1 billion. Credit depends on the type of business and the content
and quality of the collateral. Frequently, the credit granted is more than
the net worth of the business.
The increased cash availability
provided by asset-based lenders often makes
the difference between profitable growth and
failure for the undercapitalized business.
The
phrases "too small," "too
new," and "not enough net worth," do
not deter an asset-based funding source.
The
flexibility and cash availability provided
by asset-based financing have enabled
countless companies to grow and take advantage
of market opportunities.
Cost
The cost of asset-based loans is influenced by the credit risk and collateral
associated with the transaction. When evaluating an asset-based loan, borrowers
should assess the cost of financing in the context of the benefits to be
received. Compared with other financing alternatives, asset-based lending
is very cost effective and efficient.
Asset-based lenders frequently
look beyond financial statements to determine
how much money they are prepared to advance
at and after closing. Therefore, borrowers
can take advantage of profit opportunities
in the market by being able to plan ahead based
upon their cash availability.
Asset-based lenders
are proactive rather
than reactive and can often restructure debt
during tough times to help avoid costly and
disruptive refinancing.
Over the long haul,
the benefits will tend to offset the premiums associated
with borrowing from the asset-based financial
services industry.
Types
of Asset-Based Financing
Secured lending
The lender provides funds secured by the assets of the borrower. The collateral
can include: accounts receivable, inventory, machinery, real estate, patents,
trademarks or other assets where value can be determined.
The secured lender
may establish a revolving loan where the borrower provides
a pool of collateral that the lender translates
into operating cash or working capital. The
borrower uses the financing to buy more materials,
expand marketing, improve productivity or other
improvements and sells the resultant product.
The sales create receivables that are pledged
for cash advances and the payments received
on the invoices pay down the loan. These increases
and reductions in the loan balance are cyclical,
hence the revolving nature of the loan.
Some
receivables have less collateral value, for example, progress billing, past
due receivables, and receivables subject to "set-off".
Raw materials and finished goods are normally
acceptable collateral, but work-in-progress
generally is not. Equipment and real estate
may also be used as a source of financing.
Non-recourse factoring: The
financing institution buys the receivable and
assumes the risk of customer credit. The factor
guarantees against credit loss, unlike a secured
lending facility. The factor will also check
credit, undertake collection and manage bookkeeping
functions.
Full-recourse
financing:The
financing institution accepts assignment of
the receivable but does not assume the credit
risk. The client retains responsibility for
managing the receivable portfolio. Generally,
the lender will finance invoices up to ninety
days from delivery of goods or services, then
charge them back to the client.
Discount factoring: The
factor purchases the receivables at a discount
to compensate for paying prior to the due date.
Maturity factoring: The
factor purchases the receivables, assumes the
credit risk and advances cash to the client
as the invoices mature.
Non-notification factoring: Account
debtors are not notified of the sale of the
receivables and the invoices are either paid
to a lock-box or to the shipper. This is similar
to a receivable loan.
Notification factoring: Account
debtors are notified of the purchase of the
receivables and are directed to make payments
to the factor.
Spot factoring: A "one
shot" transaction, generally out of the
normal course of business. (for more about
factoring, click Here)
Floor plan financing:Certain
industries require significant high-priced
finished goods inventory. Examples: automobiles,
refrigerators, washing machines, televisions
and stereo systems. These are supplied on
extended credit terms to retailers. Retailers
usually do not purchase this expensive inventory
outright; rather a finance company will provide
credit to purchase the inventory, secured
by the product "on the floor".
Leasing: The lessor
purchases the equipment needed to fulfill certain
obligations and the equipment remains the property
of the lessor even after all the borrowed funds
are repaid; or existing assets are sold to
and leased from a leasing company to release
capital needed for working capital purposes.
Purchase order financing: Working
capital financing is secured by a security
interest in existing purchase orders and the
proceeds of the purchase orders. Normally the
security interest is perfected by the lender
taking possession of the inventory or raw materials.
Real estate financing: the
mortgaging of land and/or buildings to raise
working capital.
More about factoring
The origin of the factoring
industry has been traced to the days of the Roman Empire
or even earlier, but the industry as we
know it today in the United
States goes back only about 200 years to the early nineteenth century.
Factors
evolved from U.S. selling agents for European textile mills. The European
mills used the agents to sell their fabrics
in the U.S. and paid the agents a commission
on sales. The agents also warehoused merchandise
and did the shipping for their European clients.
As these selling agents prospered and became
more familiar with their own customers, they
began taking on the job of establishing credit
terms and advancing funds to the European
mills. The oldest documented factoring firm
traced its roots to 1810 and several others
were established in the first half of the
nineteenth century.
Traditional or old-line
factoring is fairly straightforward and is designed for long-term
relationships. It involves the purchase of
receivables without recourse and with notification
to the client's customer. The factor buys
the receivables created by a client's sales
and then collects the proceeds directly from
the client's customer. After the factor buys
a receivable, it assumes the credit risk
on that receivable. If the client's customer
doesn't pay because of a credit problem,
the factor must assume the loss.
Essentially,
an old-line factor offers its clients credit
protection, collection, bookkeeping
services and financing. In addition to advances
against receivables purchased, once a relationship
is established, factors often provide clients
with over-advances during peak shipping seasons.
Factors also offer financing services and
accommodations such as inventory loans, letters
of credit/import financing and equipment
financing. Export financing is also available
through alliances with international factoring
networks. Principally because credit guarantees
are important in textiles and apparel and
because of factoring's roots in the textile
industry, about 70 percent of the volume
of old-line factors is still in textiles,
apparel and related industries.
Since the
factor takes the credit risk on the sale,
it must first approve the sale
through its credit department. Thus, the
client is relieved of the cost of running
a credit department. Because of the credit
guarantee, old-line factoring is limited
to industries in which credit information
is available. The charge for the credit and
collection service, called the factoring
commission, varies with the sales volume
of the client, the size of the transactions
and competitive conditions.
The economic rationale
for the factoring service is fairly obvious.
With thousands
of suppliers selling to the same customer,
without factoring, each seller would have
to do its own credit appraisals and collections.
This involves an incredible duplication of
effort. With factoring, a single credit department
operating for hundreds or thousands of suppliers,
eliminates much of the duplication and promotes
efficiency. And with the aid of electronic
data processing, the cost of the credit and
collection operation has been reduced exponentially
and the savings are passed on to the client.
Technology has revolutionized the industry,
eliminating tons of paperwork and providing
clients with valuable on-line information.
The system can generate a host of reports
on sales analysis and other information to
help a client analyze its own business.
It
should be noted that the factor's guarantee,
is a credit guarantee and does not apply
to anything other than the financial inability
of the client's customer to pay. The guarantee
does not apply to merchandise disputes between
the buyer and the seller. If the receivable
is not paid because of buyer claims of defective
merchandise or untimely delivery or any other
dispute involving the merchandise or its
delivery, the factor will look to the client
(the seller) for reimbursement.
The credit
and collection service is just half of the
business of the old line factor.
The other half, and for many clients, the
more important half, involves advances of
funds against the purchased receivables.
If the customer wants a cash advance, it
can borrow from the factor. The interest
on the loan is in addition to the commission
and is usually at a rate competitive with
the cost of a comparable bank loan.
Many factoring
clients are maturity or non-borrowing clients.
They wait until the purchased receivables
are paid and then may collect the proceeds
from the factor. If the client leaves the
funds with the factor after collection, the
factor will pay interest on the balances
at a rate comparable with the factors' cost
of funds. These balances may be drawn upon
when needed.
Traditionally, factoring was
done on a notification basis. The client's
customer is notified
that the account has been turned over to
a factor and the customer's payment should
be made directly to the factor. However,
a non-notification agreement can be worked
out. The factor would still purchase the
receivables outright after doing the normal
credit check of the customer, but the customer
wouldn't be notified that its account has
been sold. If the client borrows money, customer
payments in non-notification accounts are
usually sent to lock-boxes which the factor
administers.
Aside from old-line factoring,
there are as many variations on factoring
as there
are entrepreneurs who choose to use the name.
There are commercial finance companies, some
of which call themselves factors, single-invoice
factors, purchase order factors, recourse
factors, invoice discounters and re-factors.
• Commercial
finance companies do not provide credit guarantees,
but lend against
collateral, principally receivables and inventory,
and are an offshoot of the factoring industry
and go back to the beginning of the twentieth
century. Largely because the commercial finance
companies operate in diverse industries in
contrast with traditional factoring which
is still largely married to textiles and
apparel because of the need for credit guarantees
in those industries, it has grown much more
rapidly than traditional factoring. Rather
than purchasing receivables, commercial finance
companies take assignments of receivables
as collateral for loans. The client collects
the receivables proceeds and uses the funds
to pay down the loan. Defaulted receivables
are the client's problem (but could be the
lender's problem if defaults are substantial).
The lender normally provides enough of a
cushion so that if the client fails to repay
the loan, the collateral can be liquidated
and provide full payment.
• Single-invoice factors provide essentially the same services as the old-line
factors but they do it one invoice at a time. Also, there are very few non-borrowing
clients for single-invoice factoring because a company that factors a single
invoice usually is motivated by the need for financing.
•While factors finance receivables after they are created, purchase-order
factors provide financing so clients can fill orders that they cannot finance
on their own. Once the order is filled and is converted to a receivable, a traditional
factor might purchase the receivable and cash out the purchase order factor.
•Recourse
factors are usually small factoring companies that purchase receivables
often in non-traditional industries where
credit information is not readily available.
They buy the receivables but those that are
unpaid are charged back to the client.
• Invoice
discounting is similar to the recourse factoring
and is prevalent in
England and some other European countries.
The invoice discounter buys receivables,
but rather than focusing on the credit worthiness
of the client's customer, they concentrate
on whether the contract creating the receivable
allows sale or assignment. Non-paying receivables
are charged back to the client.
• Re-factors
provide the same services as old-line factors,
but they work with small
companies, sometimes with sales volume as
low as $500,000 (generally large factors
need at least $3 million in volume). The
re-factors provide the financing, but use
the services of traditional factors to handle
the credit checking and credit guarantees.
They make their money from interest on money
advanced and a spread between the re-factors
commission cost and what it charges its own
clients.
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2005 - Commercial Finance Association - All Rights Reserved
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