As companies continue to seek working capital to finance their strategic
plans, many are finding that an asset-based structure, rather than a traditional
cash-flow loan, can provide greater liquidity
and flexibility. By pledging business assets
as collateral for a loan, companies can
secure the capital they need to support a
rapidly growing business, execute a leveraged buyout, or facilitate a turnaround
financing plan. For companies with owners
who seek to diversify their equity interests,
but who have not been able to effectuate a
sale, this type of leveraged lending can provide for a significant distribution as an intermediate step to an eventual sale.
Smart Business talked with Tom Gutman,
senior vice president and Mid-Atlantic marketing manager for PNC Business Credit’s
Philadelphia office, to learn how a business
with solid assets and thorough, reliable
accounting data can use its collateral to support growth.
Are there advantages to an asset-based loan
structure?
Asset-based financing is based primarily on
a company’s assets, so when those assets are
strong, lenders can extend credit to a variety
of businesses; even those with a higher-risk
profile, such as those experiencing rapid
growth, conducting leveraged buyouts, earning profits only seasonally, or even those in
distress.
For companies susceptible to commodity
price fluctuations, like those using plastic
resins and other products made from
petroleum derivatives, higher dollar levels
of accounts receivable and inventory may
necessitate higher levels of financing but
do not necessarily translate into increased
operating profits. Accordingly, companies
like these can find themselves out of favor
with traditional cash-flow loan arrangements based exclusively on funded debt to
EBITDA multiples.
How do asset-based loans compare to cash-flow loans?
In today’s lending environment, borrowers now find asset-based loans much more competitive in terms of interest rates and
structure flexibility. Lenders also are often
able to build in unique terms when structuring these loan agreements, such as an
asset-based loan with a cash-flow component, also known as an overadvance.
Under this hybrid solution, companies get
the borrowing base leverage of an asset-based structure with the flexibility of a
cash-flow solution. The overadvance is not
covered by the availability of funds provided by the assets; rather a lender looks at
the company’s historical cash flow and
ability to repay the debt.
In what business situations is an asset-based
loan structure most appropriate?
- High sales growth: During periods of
high sales growth, liquidity or access to
available cash is vital to a company to meet
its working cash needs. Under an asset-based revolving loan, cash availability
increases as a company’s accounts receivables and inventory balances grow. In such
circumstances, lenders also can offer a
company with seasonal swings in inventory a revolving loan with a higher advance
rate against the company’s assets during its
peak inventory build-up period. - Leveraged buyouts: Businesses should
consider an asset-based loan as a means to
leverage the value of their assets and the
assets of the target company to successfully finance M&A activity. - Recapitalization: A recapitalization
involves a business owner borrowing
against the value of the company’s assets
and paying him/herself a dividend with the
loan proceeds. This allows the owner to
‘cash out’ some of the equity that exists in
the company without selling or diluting the
business owner’s stake in the business. - Restructurings: Similar to recapitalizations, restructurings involve the use of
excess availability derived from asset-based
loans to pay off higher-priced subordinated
debt, such as seller notes or mezzanine
loans. Both recapitalizations and restructurings are typically arranged for companies
that have adequate assets, low leverage and
significant positive, tangible net worth. - Slow growth cycles: Asset-based lending has become prevalent during stalling
economies because lenders can take comfort knowing that a borrower’s assets serve
as collateral for the loan when the business’ sales and cash flow begin to decline. - Transitional periods: Typically in turnaround situations, the company’s existing
lender has limited credit tolerance for further supporting a distressed situation.
However, an asset-based lender may consider the company still viable and deserving
of a ‘second chance’ if the business has suffered operating losses due only to an identifiable and understandable operational, managerial or market-related setback.
This article was prepared for general information purposes only and is not intended as specific
advice or recommendations. Any reliance upon
this information is solely and exclusively at your
own risk.
THOMAS GUTMAN is senior vice president and Mid-Atlantic
marketing manager for PNC Business Credit’s Philadelphia office.
Reach him at (215) 585-5220 or [email protected].
