Asset-based lending business insights

There are many false perceptions and myths surrounding asset-based lending. A closer look at the components of these loans demonstrates how this versatile lending product:

1. Applies to all companies
2. Has manageable reporting features
3. Is a cost-effective tool to support your business goals 
    

Asset-based lending: An overview

Asset-based lending is a form of secured credit based on the value of the borrower’s underlying collateral. Structured as a revolving credit facility, asset-based financing may be coupled with a secured term loan.

The credit capacity of an asset-based revolving credit facility is founded on the borrower’s current assets; typically accounts receivables and inventory. Funds are advanced up to a defined percentage of accounts receivables and eligible inventory, which helps a company enhance its liquidity and working capital management. A secured term loan linked with an asset-based revolver is used for longer-term capital requirements, including debt refinancing and funding for capital projects. Pledged assets for a secured term loan are usually machinery, equipment, and real estate.

Because asset-based loans depend on the collateral base, lenders require detailed reporting to monitor changes in the underlying assets. Furthermore, lenders ordinarily conduct field examinations and appraisals to verify the value and quality of pledged assets and the integrity of financial reporting. While this type of monitoring and oversight exceeds that necessary with traditional lending, well-managed companies often find the information required is consistent with data they are already tracking. Others find it to be a valuable improvement to current management reporting.

In addition, the collection of receivables is often directed to a lockbox or separate account to pay down the revolving credit facility quickly and efficiently with cash receipts. For many borrowers, asset-based loans represent an appealing alternative to traditional cash flow–based business loans.
 

Asset-based lending vs. cash-flow loans: What’s the difference?

Cash-flow loans are based on a company’s enterprise value — often expressed in terms of earnings before interest, taxes, depreciation, and amortization (EBITDA) — rather than the value of the company’s pledged assets. Due to the differences in their credit structures, asset-based loans can provide advantages over cash-flow loans.

Superior flexibility

Cash-flow loans include restrictive covenants such as fixed-charge coverage, capital expenditure constraints, and leverage requirements. These covenants place limits on borrowing capacity and could lead to increased costs in the event of a breach. In comparison, financial covenants associated with asset-based loans are typically not as restrictive as those found in cash-flow loans. This allows greater flexibility for borrowers using asset-based loans. For example, asset-based loans typically include only a fixed-charge coverage ratio covenant that may be “springing,” i.e., it is not tested as long as loan availability remains above the agreed-upon percentage of the company’s borrowing base.

Additionally, because the capacity of a cash-flow loan is often based on debt/EBITDA, its funding availability can be volatile due to seasonal needs and/or market and economic conditions. The credit capacity of asset-based lending is not subject to this variability, however, as it is dependent upon on the borrower’s assets rather than debt/EBITDA.

Example of asset-based lending flexibility

The experience of a West Coast–based food brand serves as a good illustration of the flexibility realized by an asset-based credit facility. Demand for the company’s leading food products historically picked up in the fall, requiring the company to add inventory in the summer months. However, the company’s traditional credit facility included balance-sheet leverage covenants that were in conflict with the seasonal inventory accrual, hindering its ability to satisfy customer demand and grow the business. An asset-based revolving credit line enabled the food distributor to double the size of its credit line, which empowered its management team with more flexibility, less restrictive terms, and greater borrowing capacity based on the value of the company’s inventory.

Greater capital efficiency

An asset-based loan is typically fully secured with current assets rather than future cash flows, and therefore has the potential to reduce the borrowing cost compared to that of a cash-flow loan (which may be unsecured or only partially secured.) In addition, asset-based loans can play a vital role in optimizing a company’s capital structure.

“A business should mirror credit facilities with its short-term and long-term capital needs and the evaluation process should include an asset-based structure in order to derive the most flexible solution,” said Michael Panichi, Group Head, KeyBank Business Capital. Asset-based loans provide the company with liquidity and flexibility when used with other financial tools, which — depending on the size and nature of the company — may include leases, mortgages, subordinated debt, institutional term loans, or high-yield debt. Generally, due to the secured nature of asset-based lending, creditors may be more comfortable with higher debt/EBITDA or balance sheet leverage.

Candidates for asset-based credit solutions

Asset-based financing solutions can be both prudent and practical for:

• Companies with expansion plans (either organic or via acquisition)
• Seasonal or cyclical businesses encountering cash-flow strains throughout the year
• Businesses that require liquidity as part of an ownership succession financing plan
• Organizations undertaking recapitalizations, refinancing, and restructurings
• Turnaround situations

A compelling financing option for a variety of companies, asset-based lending is a particularly good solution for manufacturers, distributors, wholesalers, retailers, and select service businesses. Businesses with strong management teams and disciplined financial reporting capabilities are especially well suited to meet the monitoring requirements of asset-based credit facilities by leveraging a vast array of asset-based lending products, including:

• Secured revolving credit facility against working capital assets
  
• Short-term over-advance facilities for seasonal businesses
• Secured term loan facilities to support long-term assets
• Senior stretch term loans to support bridge financing

A business expansion tool

Today, many companies look to asset-based credit to support business expansion, as illustrated in the following examples:

Services
A privately owned East Coast company recognized the opportunity to take its business to the next level with a contract to supply fuel to public agencies and local governments.

To be competitive in the bidding process, however, the company needed to increase its borrowing capacity and restructure its existing debt.

An asset-based credit facility enabled the company to leverage its assets and obtain higher borrowing capacity than that available through a more traditional commercial bank loan. Additionally, the asset-based credit facility also had fewer covenants and restrictions than the company's existing debt, providing management with greater flexibility to run the business.

Manufacturing
For a privately owned fastener distributor with operations in the United States and Canada, asset-based credit played an important role in refinancing the company’s existing debt. The facility also provided the company with a flexible financing source, helping the it expand into new geographic territories.

Asset-based credit financing from KeyBank Business Capital

KeyBank Business Capital has the experience, resources, and expertise to help companies with asset-based financing solutions. Raising over $1 billion in asset-based loan commitments in 2022 alone, KeyBank has helped a variety of middle market and large companies across multiple industries meet their financing needs.

What makes Key unique is its culture focused on a commitment to long-term client relationship management: We provide solutions best suited for the needs of each individual client. It is not uncommon for a business to seek greater flexibility under asset-based facility and perhaps migrate back to a cash flow structure, or vice versa.  Given KeyBank’s relationship governance, this process provides continuity through the company’s agency of institutional knowledge.

KeyBank’s industry specialists represent another distinctive characteristic and important advantage for its clients. Industry-leading payment and cash management solutions, for example, enable clients to optimize their cash flow and reporting efficiently, effectively, and seamlessly through our asset-based lending solutions. Key clients also gain access to specific vertical industry expertise and developments, as well as valuable knowledge of ever-changing market trends.

To learn more, contact Michael Panichi, Senior Vice President, Portfolio Management Group Head, KeyBank Business Capital