Key Differences between Asset-Based Lending and Traditional lending

I often get asked this question, so here goes.

The most typical type of Asset-Based Lending or “ABL” is made against the business’s accounts receivables. Other assets that can comprise a facility include inventory, capital equipment, and real estate. Because receivables have greater liquidity, they are frequently the largest proportion of collateral for these loans and provide a high advance rate, typically in the range of 70 percent to 90 percent. Contrast that with inventory, which has a typical advance rate of 50 percent but that is also industry dependent.

ABL provides a flexible approach to financing a business’s current operations and needs for future growth, especially if you have quality receivables (which can be a hurdle). In contrast to traditional bank lending, where the borrowing company’s operations are evaluated and its future cash flow is projected, asset-based loans are based on the collateral put up for the loan.

An asset-based loan typically takes the form of a revolving line of credit, which is refreshed when the collateral, e.g., the receivables, are paid down. The creditors submit payment to the lender, and when the funds are collected, the lender provides the balance to the borrower, minus the fees it charges for the loan and for managing the collections process.

Challenges Using Receivables as Collateral

There are many challenges when using receivables as collateral or financing receivables on a transactional basis. Below are just a few examples:

  1. Goods owned by or secured by others but sold by borrower – what if a borrower sold goods with a trademark that is not owned by them and was never authorized.
  2. Rendition of services – financing the service industry poses many unique problems versus goods sellers. Service providers may have multiple entities and it may be difficult to ascertain which one did the service. Borrower may have a business structure for tax purposes or other reasons that deliberately divides its service functions amongst its’ entities.
  3. Bill and hold receivables – Seller bills customer when goods made, but holds them, possibly because the customer may not have storage space due to seasonal items. Difficult to finance transactions that are not complete.
  4. Hidden or competing liens – If a borrower is a contractor or sub that performs work backed by a payment or performance bond, a lender must be careful about extending credit based on receivable. The bonding company (the surety) may by means of subrogation, obtain priority over perfected security interest over the borrower receivable.
  5. Non assignability clauses in purchase orders- Sales agreements or purchase orders between borrow and customer sometimes have provisions stating receivables cannot be assigned. This provision is not effective under U.C.C.
  6. Contra Accounts- Can a buyer offset a receivable because the supplier may have leased property or borrowed money or purchased goods or services if borrower fails to perform obligation? For example, a company buys coal from a borrower and they go bankrupt, can they offset outstanding receivable with cost of procuring new coal supply? Or if receivables to be financed are under a master supply agreement that covers more than just one or two receivables, the customer may have a right of offset if the borrower fails to perform.

Developing ABL solutions is not for the faint of heart. Collecting, profiling, matching and analysis of a company’s receivable data requires the right tools and personnel.  Assessing obligor risks and calculating receivable eligibility requires more than just the right tools and technology.

And then of course the program must be monitored, including screening for fraud and making sure cash receipts tie back. The operational support to do these programs takes a combination of technology, managed services, and quality personnel.

There are many players in this market, some specialize by industry sector, while others focus on entrepreneurial lending or the middle market.

A good source for lenders in this space include the Commercial Finance Association and the International Factoring Association.

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