Asset-based lending Featured

7:00pm EDT January 31, 2007

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