There comes a time for every business when they need additional working capital. Where do businesses go when they are in need of financing?  Typically, the go the bank.  A common way to get access to funds is through a traditional bank line of credit. However, there are additional options available when a bank line is either not accessible or does not adequately meet your needs. If you have been searching for an alternative, you may have heard the term “Asset Based Lending,” “ABL,” or “Asset Based Financing” and may be wondering what it is, how it can help you and how does it compare to a bank line? The differences can be quite significant, so let’s take a look at what they are.

Conventional Bank Lines of Credit

With a conventional bank line of credit, the loan is usually made on the strength of the balance sheet and the income statement with collateral being a secondary consideration. Collateral is not usually routinely monitored. Banks look for strong positive equity, modest debt to equity ratios and reliable earnings with cash flows adequate to comfortably meet the interest and principal repayment terms of the loan.

For conventional bank lines, there is generally very little monitoring that often consists of an annual or quarterly review of financial statements. The monitoring is typically done to ascertain compliance with financial covenants with audits being performed infrequently, if at all. Pricing is typically quite low, but the loan amounts that are available may be lower than could be obtained with asset based lending for various reasons.

Most of the underwriting and approval process is based on recent historical financial performance and is often very time and paper intensive. For that reason, a very rapidly growing company or a company with financial adversity in its recent past may have difficulty obtaining enough funding to take full advantage of growth opportunities. Additionally, that means that if the amount you need to borrow increases it can be difficult to get the line increased without needing to start from the beginning again.

It goes with out saying that conventional banks that are regulated by the government and federally insured offer conventional bank lines of credit. They have very low cost of funds because of their deposit base, various sources of revenue and because they keep low head counts, relying heavily on their periodic financial review to control costs and attract investors.

Asset Based Financing

An ABL loan or line of credit is tied directly to the value of assets the borrowing company owns. Those assets almost always include accounts receivable as the largest asset class supporting the loan. The amount of borrowing available may also be tied in some amount to inventory, plant equipment, work in process, and real estate values. Due to ABL financing being collateral focused it is more forward looking compared to conventional bank financing which looks more to the past performance.

Most asset based lenders prepare or require the borrower to prepare a borrowing base certificate on some regular schedule to document the assets available to support the loan and to determine the size of the loan to be made available to the borrower. Lenders vary the frequency at which the borrowing base certificate is prepared depending upon the credit strength of the borrower and the type and value of the assets supporting the loan. It may be done on each draw request, weekly or monthly.

Often, periodic audits are required to verify the collateral value of the supporting assets. Audits may be performed quarterly, semi-annually, or annually depending, again, upon the financial strength of the borrower and the type and value of assets. Because this documentation, monitoring, and auditing process requires a great deal of attention, and recurring work for the lender, asset based financing is usually more expensive than conventional borrowing but may be available in larger amounts. For financially challenged large to mid-sized borrowers and the small business borrower asset based financing may be one of the only financing options available particularly in start-up or growth situations.

Typically Asset based financing is offered by specialty, non-bank lenders but more and more “Main Street” banks are offering an ABL product to permit them to serve more borrowers that may not qualify for a conventional bank line of credit.

Pricing, advance percentages, and administrative burden vary significantly from lender to lender. Borrowers are best served if they clearly understand their needs and shop thoughtfully and thoroughly for the best fit. 

For many small and growing businesses that are in some sort of transition, one big, often-unconsidered, benefit of utilizing asset based financing is that it can provide your path to a conventional bank line. The reason is that asset based lending can provide the working capital you need today to help lead you to a solid history of a strong balance sheet and income statement.  

So What is Best for Your Business?

There are many considerations you must take into account when deciding which type of financing is best for your business. Hopefully, this gives you a clear understanding of the differences between a convention bank line of credit and asset based financing and how your business can benefit from each.