What is an asset-based loan?
An asset-based loan is secured by a company's accounts receivable, inventory, equipment, and/or real estate, whereby the lender takes a first priority security interest in those assets financed. Asset-based loans are an alternative to traditional bank lending because they serve borrowers with risk characteristics typically outside a bank's comfort level.
What's the difference between asset-based lending and traditional bank financing?
The primary difference between asset-based lending and commercial bank financing is what the lender looks to first for repayment of a loan. A bank will look first to the cash flow for the repayment, then to collateral. An asset-based lender looks to collateral first. Since banks underwrite cash flow as their primary repayment source, they typically require less collateral controls and monitoring but more financial covenants.
For "asset rich" companies, an asset-based loan may make more funds available because it is not based strictly on the anticipated levels of cash flow. Additionally, the structure often requires fewer covenants, providing more flexibility for many borrowers.
What is typically included in an asset-based loan agreement?
A typical loan agreement with an asset-based lender provides protections, rights, and remedies for both parties. It also establishes guidelines on how the asset-based loan is to be administered and how expectations are to be met. In addition, the asset-based loan agreement may include a limited number of restrictive and/or financial covenants, but these are typically fewer than conventional commercial loan agreements.
How does an asset-based lender monitor its borrowers?
The level of controls and monitoring by the asset-based lender is directly related to the credit-worthiness of the borrower. Typical controls include:
- Borrowing base formula: A borrowing base formula that monitors the relationship between the value of the collateral available to secure the outstanding loan and the actual balance of the loan on a regular basis.
- Collateral reporting: Funding controls, or collateral reporting, may be required daily, weekly, or monthly and range from submission of sales invoices/shipping documents to accounts receivable aging and listings/inventory listings.
- Collection controls: The asset-based lender requires dominion, or control, over cash by establishing a collateral account into which accounts receivable collections are deposited. Access to this account is restricted to the asset-based lender.
- Ongoing audits: Ongoing audits are also used to monitor the account. The asset-based lender will audit the borrower's books and records periodically to verify the accuracy and validity and to substantiate collateral values as represented by the borrower.
What is a revolving credit facility?
A revolving credit facility, also known as a "revolver," is designed to optimize the availability of working capital from the borrower's current asset base. As the borrower repays a portion of the loan, an amount equal to the repayment can be borrowed again under the terms of the agreement. Eligible assets commonly included in calculating the current asset base are accounts receivable and inventory.
The term "revolver" is used because the amount the asset-based lender is willing to lend increases if the amount of the assets securing the loan increases. Funds are loaned to a company based on a certain percentage of the value of eligible accounts receivable and inventory. Such loans are limited by the predictability of cash flow to service the debt.
A revolving line of credit typically has a term of one-to-three years with renewal provisions. The advantage of a revolving credit facility is that the company can use current assets as collateral to secure a loan rather than wait until the collateral has been converted to cash.
What is a term loan?
One component of senior debt is a term loan. This is typically an asset-based loan that is based on a certain percentage of the orderly liquidation value of the machinery and equipment and the appraised fair market value of the land and buildings.
Asset-based loans against equipment and real estate are often made in the form of term loans that include regular periodic payments of both principal and interest in order to retire the debt at a fixed maturity date. Asset-based loans using real estate as collateral have longer maturities than equipment loans because of the generally shorter economic life expectancy of equipment.
What is debtor-in-possession (DIP) financing?
Debtor-in-possession (DIP) refers to a company that has filed for protection under Chapter XI of the Federal Bankruptcy Code and has been permitted by the bankruptcy court to continue its operations to effect a formal reorganization. A DIP company can still obtain loans-but only with bankruptcy court approval.
DIP financing, which is a new debt obtained by a firm during the Chapter XI bankruptcy process, allows the company to continue to operate during a reorganization process. Asset-based lenders are well versed in providing DIP financing, confirmation financing, or exit financing as companies emerge from bankruptcy protection.
What is EBITDA?
The term "EBITDA" stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It is a financial tool often used to measure a company's cash flow and ability to service its debt. It is a legitimate tool for analyzing lower-rated credits, but less appropriate for higher rated credits. To compute EBITDA, add back interest expense, depreciation expense, and amortization expense to pretax income.
What is LIBOR?
The term "LIBOR" is an acronym for London Interbank Offered Rate, which is the market interest rate charged by lenders and paid by borrowers for U.S. dollars outside U.S. borders (commonly called Eurodollars).
LIBOR is quoted on a daily basis representing fixed time periods ranging from 30 days to 360 days. The rate is set not by banks but by market forces in the supply and demand of Eurodollars. Interest rates on senior acquisition financing are normally based on a floating rate related to either the prime rate or LIBOR.
Is Bank of America Business Capital the right lender for my business?
Bank of America Business Capital is one of the largest asset-based lenders in the world. It has extensive asset-based lending experience in a wide range of industries and business sectors.
Whether you are a manufacturer, distributor, retailer, or service organization, Bank of America Business Capital will work to understand your company's unique business needs to structure an asset-based loan that helps to meet your company's strategic goals.
Bank of America Business Capital understands how to value virtually any type of collateral and is well-equipped to respond quickly to your financing needs.
To further answer your questions regarding asset-based loans, or to arrange a consultation, please contact us online. To stay informed on a variety of asset-based lending topics, sign up for our free CapitalEyes e-newsletter on leveraged finance.