Using Your Inventory as Collateral in an Asset Based Loan

Asset–based borrowing can be a powerful financing technique for speeding cash flow and helping your company grow. How hard is it to borrow working capital for a low-margin business that has a thin capital base? If you think it’s difficult, you should think again. If you run such a business, you might qualify for asset–based borrowing, a powerful financing technique that can speed cash flow and help your company grow. The technique works especially well for manufacturers, wholesalers, and distributors, but other businesses use it effectively as well. Using your inventory as collateral in an asset based loan free up capital.

What’s more, banks and finance companies, flush with cash these days, are competing to sell such loans, making them a cheap source of working capital.

As the name implies, an asset–based loan is a revolving line of credit secured by assets such as receivables, inventory, or both.

In a very real sense, an asset–based loan cuts the time it takes to turn these valuables into cash–the key to profits in businesses operating on low margins, such as wholesaling and distributing.

With an asset–based loan, you:

• Borrow against receivables or inventory;
• Use the capital to buy more inventory; and
• Pay interest only on what you borrow while you’re borrowing it.

If you default, the bank seizes the assets that secure your loan.

The bank cushions its risk by advancing only a percentage of the value of your assets–as a rule, 65 to 85 percent against receivables, up to 55 percent against inventory.

The catch? Paperwork. Asset–based borrowing can do good things for your business, but you have to plow through red tape to realize them. (See “Paperwork Aplenty,” Page 43.)

A Growth Strategy

Robert B. Bregman Jr., president and managing general partner of Los Angeles-based, knows the benefits of asset–based borrowing first hand. His company supplies guestroom amenities to cruise ships and scale hotels. It also sells plates, saucers, tableware, and other specialty items to airlines.

In 1988, WESSCO’s revenues stood at $5.5 million. This year, Bregman expects to see $20 million–a growth rate of 15 percent per year that Bregman attributes to asset–based borrowing.

WESSCO’s airline clients include American, United, Delta, Alaska, America West, and Northwest;. The company supplies the Ritz-Carlton, Intercontinental, and Four Seasons hotel chains and the Cunard, Carnival, Seabourn, and Norwegian cruise lines.

To get the best terms, Bregman pays his in Asia with letters of credit or via telex transfers. But he might wait four months or longer to receive payment from his customers in the United States. To bridge the time gap, Bregman finances his receivables with an asset–based revolving line of credit from Comerica Bank of California, a unit of the major Detroit bank holding company.

Comerica, one of the most active asset–based lenders in the country, targets small and middle-market companies in Michigan, Ohio, Indiana, Florida, Colorado, Texas, and California. Banks across the country offer asset–based loans, as do commercial finance companies.

“I may get an order from American Airlines to supply porcelain for a year,” Bregman says. The airlines usually want deliveries staggered over time so they can replace items as they break or wear out, he explains. He typically makes a first delivery 90 days after he has ordered the goods and the rest at 30-day intervals thereafter.

“You can see I won’t invoice American Airlines for the first delivery until three months out, and I won’t get paid for 30 days after that,” he says. “For some of the order, I won’t get paid for more than a year. But if I want the best terms from my suppliers, I have to pay them soon after they ship. My loan facility with Comerica bridges the time gap.”

Strong Receivables

Put another way, asset–based borrowing allows you to cut the cost of goods from its suppliers and to speed turnover.

Bregman first learned about asset–based borrowing 10 years ago from a loan officer at another bank, and he quickly saw the benefits of the idea.

“We were relatively small at the time, and it seemed like the answer to rapid growth,” Bregman says. “Once we understood how it worked, we recognized that it would be good for us.”

The key to his program is the strength of his receivables-all from big-name customers. Indeed, asset–based lenders don’t worry as much about a company’s net worth or even its financial history as they do about the strength of the asset against which they lend. With receivables, customers are key.

Frank Gaddy, a senior vice president at Comerica who oversees nationwide business credit operations out of corporate headquarters in Detroit, says, “There has to be some basic integrity to the balance sheet, but in asset–based lending, that means less than it does in traditional business lending.”

Costs And Procedures

What does such a loan cost?

A creditworthy business can borrow against assets at the prime rate plus two percentage points, sometimes less, Gaddy says. Some lenders peg their rates to the London interbank rate known as LIBOR, which generally reflects the cost of U.S. Treasury bills plus 175 to 200 basis points. (A basis point is one one-hundredth of a percentage point.)

“We love to finance a company experiencing the cash-flow problems common to new businesses,” Gaddy says. “These businesses need working capital to finance growth, and even if their balance sheets and profit-and-loss statements don’t look so good, they have good prospects. Asset–based lending can really propel companies like these to big growth.”

What it did for you was to generate a decade of growth at 15 percent annually–a growth rate many business owners would kill for.

“Asset–based financing makes life predictable,” Bregman says. “We get the funds we need to make us grow, and this kind of borrowing makes our cash flow manageable.”

This story is part of a continuing series on ways for small companies to locate the financing they need to run their businesses.

Paperwork Aplenty

You need to push some paper to get an asset–based loan, according to Paul J. Wolf, a Los Angeles investment banker whose firm, Houlihan Lokey Howard & Zukin, puts together financing deals for small and middle-market businesses.

You push even more paper to maintain the loan, Wolf says.

For starters, you must show your banker:

• Three years of profit-and-loss statements as well as tax returns for your business.
• A current interim financial statement and such a statement from a year earlier.
• Aging reports on your accounts receivable-analyzing how much time has passed since invoicing customers without receiving payment–and on inventory for the current period and for the same period one year earlier, along with a list of your top customers.
• Your personal financial statements and tax returns for three years.
• Your sales projections for the coming year.

As a rule, you must submit updated financials and tax returns annually to maintain the loan, Wolf says.

In addition, you must report accounts payable and receivable on a monthly, sometimes weekly, basis along with a “borrowing base certificate” analyzing sales, collections, and net collateral.

“The paperwork seems onerous,” Wolf adds, “but any business owner who studies statements regularly knows that their value far outweighs the trouble of putting them together.”

In any case, most commercial business-accounting software packages compile the data automatically; and once you get your reporting system up and running, it’s not hard to maintain it, according to Wolf.

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