Securing an Asset-Based Loan with the Borrower in the Driver’s Seat
This article first appeared in TSL Express.
Corporate entities often turn to asset-based lending (ABL) as a strategic way to fund acquisitions, reduce capital volatility inherent in cash flow structures, or simply to accelerate growth. Secured by company assets, this alternative path to cash flow financing has historically followed the same process: companies choose a lending institution based on the most attractive deal structure, accept its deal terms, and undergo a field exam and asset appraisal to determine the appropriate borrowing terms. Under this structure, the lender drives the process of evaluating asset quality and identifying credit risk, and the company is often last to learn how much liquidity it can access and under what terms.
But not anymore.
Increasingly, borrowers are proactively approaching lenders with fully diligenced and competitively structured and priced origination opportunities in order to secure the best deal possible and receive the most favorable terms. This means that instead of waiting for the chosen lender to request a field exam—the due diligence analysis for asset-based loans—borrowers (often through a financial intermediary) can solicit the exam before a lending institution is identified. With the result of their field exam in hand, companies have greater insight into their calculated borrowing base availability and can establish defensible responses to actual (or perceived) credit risks that may concern a lender. From there, companies can have banks compete for their business. The result is that first-time and experienced asset-based borrowers alike can maximize liquidity and obtain lower pricing options and optimal deal terms.
The reason for the shift to a borrower-driven lending process is multi-layered. First, there has been significant growth in the number of institutions, both traditional and non-traditional, offering ABL solutions. Heightened government regulation on banks following the global economic crisis has constrained their ability to invest in what they may perceive to be low-risk, profitable deals. While these regulations, codified in the 2013 Interagency Guidance on Leveraged Lending, may ease or be lifted over time, the result has been the emergence of non-regulated lenders that are not bound by the same regulatory constraints but that are intent on filling the capital void regulation creates. Second, borrowers are eager to capitalize on favorable economic conditions and are looking to refinance, make acquisitions, and generally find access to capital quicker and on better terms than ever before. While ABL loans have historically been associated with “tougher” credits and more reliability in market downturns, discerning borrowers and lenders have always understood their flexibility and economy.
Understandably, the shift to a borrower-driven lending process can be worrisome for lending institutions, as companies now have a greater say in determining their loan terms and lenders may appear to be less in control of the process. The competitive nature of these deals will drive lenders to build close relationships with diligence providers and financial intermediaries to help support their ultimate selection, as well as ensure deal terms are sharp and relationships with the prospective borrower are strong from initial meetings. Diligence providers who are approved vendors of multiple institutions will have a leg up in participating in these borrower-driven processes, as the ABL field exam and appraisal reports will be sustainable in any banking environment.
As part of this process, lenders should be candid about their ability to accept a borrower-driven report and determine the situations that could preclude their acceptance. This includes clarification regarding who they are open to accepting work from, how much influence the lender requires over diligence scope, and how their internal credit approval process will evolve to accommodate vetting borrower-driven reports. Lenders should also make an effort to get to know a prospective borrower’s diligence provider and understand its technical ability, deal history, and whether it will be acceptable to potential syndication partners. Getting involved early in this process is key, as the sooner a lender provides competitive terms and gets the deal mandate, the quicker it can work alongside the borrower’s advisor to ensure any credit risks are addressed.
For companies in the market for an asset-based loan, however, the shift to a borrower-driven lending process comes as welcome news. As these loans are often sought by companies in capital-intensive industries, flexible deal terms and a defensible view of asset quality—such as low cash flow covenant thresholds (fixed-charge coverage), reasonable ineligible definitions, and collateral reserves—can be the make-or-break factor when choosing a lending institution. Additional terms that companies may look for when shopping around their business include seasonal over-advances and advances on non-traditional ABL assets (non-regulated lenders).
When considering an asset-based loan, it is important to be aware of the type of companies that are best positioned for this path to capital.
When considering an asset-based loan, it is important to be aware of the type of companies that are best positioned for this path to capital. Companies that may not be cash-rich, but have assets that can be used as collateral, are prime candidates for ABL. For many borrowers, the primary collateral is accounts receivable, though inventory, purchase orders, real estate, equipment, and even intellectual property may also be used. Additionally, inventory-heavy companies with seasonal needs and cyclical service offerings—such as manufacturers, distributors, and service-based businesses—may find that an asset-based loan is the right solution to ensure regular cashflow during financial down periods or to reach the next growth initiative.
Before approaching lenders, prospective borrowers should first ensure that their financial information—including financial statements, detailed asset data, and reporting systems—is accurate and comprehensive. Having a strong command of transaction-level data can support the company’s assertions regarding asset quality and lead to higher borrowing base availability, increasing access to liquidity. Often, identifying the right credit advisor is a helpful way to navigate the complexities of ABL preparedness and to determine the right starting terms from which to negotiate.
For lenders and borrowers alike, understanding these shifting dynamics will be key to navigating today’s ABL landscape. For companies considering an asset-based loan that have not yet chosen their lending institution, this means shopping their lenders to ensure that they are getting the best terms and relationship possible. For lenders, building partnerships with diligence providers will yield a reputation in the market of being forward thinking and agile and, subsequently, generate more profitable deals. As a result, both lenders and borrowers can land on deal terms that best align with their long-term goals.