Asset-based loans aren’t just for companies in trouble. Today’s CEOs see
them as one of many working capital financial tools available to them.
“An old stereotype is that asset-based
loans are for companies that are distressed,”
says Tim Mauter, vice president, commercial banking with FirstMerit Bank in
Columbus.
However, he says many businesses can
use asset-based loans to gain more freedom
to obtain loans that match their business
growth and borrowing needs.
Asset-based loans are an excellent fit for
business owners in promising turnaround
situations, as well as for manufacturing concerns and companies experiencing fast-paced growth. Seasonal businesses and
companies going through ownership transition also benefit from this type of loan.
Smart Business spoke with Mauter about
why asset-based loans are solutions for
companies at many stages.
How does an asset-based loan work?
Rather than basing a loan off a company’s
cash flow and overall balance sheet leverage, as in a traditional secured line of credit
or term loan, the asset-based lender lends a
percentage against the company’s working
capital assets. This typically includes
accounts receivable and inventory. As the
business experiences fluctuations in sales,
working capital assets increase or shrink to
match sales levels. At the same time, the
asset-based loan increases or decreases,
matching borrowings with asset levels.
What is an example of a business that can
benefit from this structure?
Manufacturing, distribution, seasonal and
high-growth businesses are great examples.
The best candidates have good internal controls and accounting software. Also, the
quality of a company’s accounts receivable
and inventory controls and its ability to
‘turn’ these short-term assets quickly is a
plus. The quality of the company’s working
capital assets also will determine what percentage the bank is willing to lend. The higher the quality of assets, the higher advance
rate the lender can offer, which translates into more borrowing availability for the borrower.
What types of businesses are best suited for
asset-based loans?
Asset-based loans fit high-growth companies or companies with a great deal of working-capital assets. Companies with direct
contracts with government entities or foreign accounts receivables also make good
candidates. With proper documentation, the
lender may be able to advance a higher percentage on these specific receivables.
Companies going through an ownership
transition or estate planning that leverage
the balance sheet may also benefit. In addition, highly leveraged companies or companies in a turnaround situation are good fits.
What is the lending formula for an asset-based loan?
Advance rates for accounts receivable
may range from 60 to 95 percent. The asset-based lender will base this advance rate on
the quality or collectability of the receivables. Advance rates on inventory may
range from 20 to 70 percent, depending on
the type of inventory and how often the borrower ‘turns’ or sells the inventory each
year. Commodity inventory or finished
goods may allow for a higher advance rate, as they are readily marketable.
In the past, asset-based lenders typically
did not lend against work-in-process (WIP)
because it was difficult to determine the
cost or likelihood of converting it to salable
inventory. Today, some lenders will lend
against WIP, but the advance rates may vary.
What qualities do banks look for in a company before extending an asset-based loan?
It is vital to demonstrate that your firm has
a talented management team, good financial
controls and is focused on the execution of
your business plan. Banks like to work with
management that has proven its ability to
succeed in good times and bad.
A quality accounting system and internal
controls indicate that a company is invoicing in a timely and effective manner, which
ultimately produces better cash flow —
including solid inventory controls. A perpetual inventory system with periodic physical
counts is a plus. Solid internal controls and
systems also will assist the borrower with
the daily, weekly or monthly reporting
requirements of the asset-based lender.
How do you know if a company’s internal controls are acceptable?
The asset-based lender will conduct a field
exam, during which the examiner will evaluate various issues, including credit policies
and collections, books and records, systems, controls and inventory. The examiner
will interview company personnel and
review accounts receivable, accounts
payable and inventory reports. In addition,
he or she may take a physical inventory or
spot-check specific items for accuracy.
Ultimately, asset-based loans allow businesses the flexibility to match their borrowing needs to actual asset (revenue) growth.
Asset-based lenders can respond quickly to
companies’ needs for more working capital
with an asset-based structure, increasing
the loan amount along with borrowers’
receivables and inventory.
TIM MAUTER is vice president, commercial banking with
FirstMerit Bank in Columbus. Reach him at (614) 545-2769 or
[email protected].
