At a time when many profitable companies are stumbling, posting net losses or weak cash flow, CFOs are increasingly finding it difficult to obtain debt financing. But even as one door–cashflow financing from banks–closes, another one-asset based lending–remains open, offering opportunities to mine a balance sheet for cash.
An Alternative Form of Debt Financing
When CFOs consider the growth plans for a company, they know that the well planned assumption of debt may be a key component of an effective strategy. Due to current economic conditions, many businesses–particularly those with high potential but less-than-stellar income statements–find the door to growth through debt acquisition remains firmly closed. It is barred by such lending requirements as financial ratios and other hurdles associated with traditional, cash flow-based financing techniques.
There are alternatives, however, according to Howard Kaufold, an adjunct professor of finance at Wharton, and Willie Brasser, managing director of the Corporate Lending Group at GE Capital. One particular option, asset–based lending, may be attractive to a wide spectrum of companies, from businesses looking to enhance their working capital to companies that are operating under Chapter 11 protection. Asset–based financing can smooth out cash gaps during business cycles, fund asset purchases and other acquisition strategies and, in general, give an enterprise the flexibility it needs to grow.
According to the Commercial Finance Association, asset–based lending is a $200 billion-plus market. Manufacturers represent about 31% Of the total marketplace, followed by wholesalers (28%) and retailers (17%).
As its name implies, asset–based lending involves financing that is secured with an item of determinable value, typically equipment or inventory. Because the nature of the collateral–which is readily identified and can be easily recovered–offers some level of comfort to lenders, qualified borrowers may be able to obtain competitive terms.
Brasser says a balance-sheet oriented approach can uncover value that may not be reflected on a P&L statement. “We don’t court risk,” he says. “But on the other hand we don’t have tunnel vision when it comes to valuation.”
An Opportunity for Some Borrowers, but Not for All
The very characteristics that may let certain businesses qualify for asset–based lending also serve to exclude others, cautions Kaufold. “Banks and other financial institutions often have a formula that specifies the percentage of inventory or equipment against which they would be willing to lend,” he says. “That is not very good news for service organizations, which may not have much in the way of tangible assets. Consequently, a significant number of companies may be effectively shut out of this alternative financing approach.”
Even when a deal is structured, asset–based lending can present some thorny issues. “For a lender, valuation can be an issue, particularly for assets that are used in highly specialized industries or market segments,” says Kaufold. “Contrast this with receivables-based financing, where the valuation is based on the receivable itself (which has an explicitly stated value) and on the ability of the customer to pay it off (which can often be determined using credit rating agencies).”
In addition to valuation, smart lenders consider a myriad of other issues. “An asset–based lender who is doing the job properly will consider a wide range of metrics, expanding the spectrum of borrowers that can qualify,” according to Brasser. “We do more than just valuing assets,” he explains. Asset–based lenders often tend to take an integrative approach, examining the entire manufacturing process, noting the time-to-collection of receivables, conducting sales trend analyses and considering such issues as the market for the borrower’s raw materials, he adds.
Compared to a cash-based financing organization, an asset–based lender assigns less weight to going concern, competition, market share and business strategy–although these issues are considered–and spends more time reviewing profit margins and determining whether the business can cover its interest expense and other debt service.