Richard Winton
Business Development Director
BNP Paribas

By Richard Winton, Business Development Director, BNP Paribas

Medium to large-cap businesses in the UK could be missing out on asset-based lending, a form of flexible financing popular in the United States that is comparatively neglected in the UK due to popular misconceptions.

When Clayton, Dubilier & Rice acquired specialist plumbing distributor Wolseley last year in a transaction valued at £308 million ($387.1 million), it caught people’s attention not only for the private equity firm’s impressive coup but also for the inclusion of an asset-based lending facility within the capital structure.

Asset-based lending is a form of borrowing backed by collateral such as business property, inventory or outstanding invoices. While asset-based lending is now well-established in the United States as a lower cost and more flexible slice of many leveraged buyout transactions, in the UK, this type of lending is often held back by dated misconceptions. Historically, this kind of borrowing has been principally used in the UK as a short-term option for smaller businesses that are growing rapidly or unable to obtain traditional credit.

Far from being an option only for distressed and smaller companies, Clayton, Dubilier & Rice showed how asset-based lending can be used for the acquisition of vibrant businesses and to fund growth. Wolseley, which was part of Ferguson plc, is an asset-intensive business with more than 500 branches, three distribution centers and reported revenue of £1.5 billion ($1.88 billion) in 2020. The deal was completed with a term loan facility from Atlantic Park and a £160 million ($201.04 million) asset-based facility in which BNP Paribas Commercial Finance was the lead arranger, working alongside three other banks.

Reduced Bank Capital Requirements

The Wolseley deal was completed in just a few weeks and highlights the role asset-based lending can play at a time when regulators are keen for banks to be cautious about leveraged finance deals. Regulation changes in recent years have reduced the amount of unsecured debt that banks can hold, changing their lending outlook as a consequence.

But lending secured against physical assets makes asset-based lending a viable alternative to other credit facilities, as it provides competitive returns while enabling lenders to hold less capital or risk-weighted assets to cover their risk.

Reduced balance-sheet requirements also mean that asset-based lending typically provides a cheaper overall cost of capital than super senior revolving credit facilities (SSRCF) and loans from private debt funds, with interest rates of 6.5% to 8% from private lenders vs. 2.5% to 3.5% for asset-based loans. Furthermore, the flexibility asset-based loans provide can free up more working capital for businesses in the months and years immediately after completion.

For example, if a deal had been agreed at £200 million ($251 million) with another £100 million ($1.26 million) needed for working capital, the total loan requirement would be £300 million ($377 million). Using revolving credit facilities could require four or five banks to be involved due to the lending ceiling for this type of lending, increasing the complexity in executing the deal. But with asset-based lending, ceilings are potentially far higher, as they are determined by the value of the physical assets used as collateral. In the same example, a deal might require only two or three banks with the money available from day one of completion. Then, as the business grows and revenue rises, the increase in turnover and the likely increase in stock levels and invoices that goes with it would provide more collateral, enabling the bank to increase the size of its loan.

Consulting firm Kroll cited the Wolseley deal as the start of an emerging trend. “We hope to see more of these much-talked-about ABL plus unitranche deals going forward, also given reduced clearing-bank appetite for SSRCFs,’’ Kroll said in a recent report.

Quick and Simpler Due Diligence

In spite of the obvious attractions, asset-based lending is still often perceived as unwieldy and slow to execute, requiring extensive due diligence both prior to the deal and after the lending has been agreed.

However, the rapid evolution of cloud and platform-based solutions has sped up the process and reduced the amount of work required in maintaining these loans. Contrary to a perceived view that asset-based lending adds to the amount of due diligence required compared with other loans, a lot of the work for these loans can be done digitally rather than over the course of multiple days offsite. Similarly, the legal side has become smoother thanks to the adoption of simplified Loan Market Association (LMA) document templates and principles. These have helped to speed up the process and made intercreditor agreements more straightforward.

In the case of Clayton, Dubilier & Rice’s purchase of Wolseley, it took just two weeks for the credit to be approved, with the whole deal taking about six weeks from start to finish. Pace matters in the highly competitive M&A environment. This speed of approval is therefore essential in keeping asset-based lending attractive when it goes up against other bids using different forms of financing.

Previously, the due diligence process was highly granular in asset-based lending, with every item needing to be checked and listed and every asset valued. Now banks can take a more holistic approach and look at the overall business, determine an asset value of, say, £100 million ($126 million) and lend against £60 million ($75.39 million) of that to get the deal done. Later, more detailed analysis will allow the bank to increase the amount it is willing to lend.

This approach has removed another historic barrier: the need to commit “certain funds”  as a commitment from a lender to finance the acquisition when the deal is signed. As this is typically needed some time before actual completion, banks have been unwilling to commit to certain funds using asset-based lending because of the detailed due diligence required on the assets. But in taking a heavily-discounted value for the loan, a bank can take a lighter touch in its initial due diligence.

Simple to Maintain

Once the loan has been agreed to, accountancy software can directly report back the figures needed to maintain the facility to the bank. Monthly borrowing base certificates, in which the borrower warrants that it has the required collateral available at each interval to underpin the loan, have replaced the previous approach that relied on fixed asset schedules. These meant a business had to provide updated lists of its assets individually every week and face time consuming month-end reconciliation exercises.

The adoption of springing cash dominion structures that are triggered only when certain thresholds are breached also means that the cash held against assets doesn’t need to be controlled by the ABL lender.

For example, if a borrower keeps its cash availability levels above, say, 15% of its outstanding loan, the company keeps hold of the cash. However, if it dips below the agreed threshold, then the cash dominion “springs” into action and the lender can take control of that cash and use it to repay the loan.

Previously, existing customers of a business that had used this credit facility would have had to pay their bills into a different bank account controlled by the lender rather than the business’ own account. For larger businesses, that can involve tens of thousands of customers having to update and switch the accounts into which they pay. Now the new mechanism lets customers carry on as before while still providing the lender with sufficient security.

Our experience at BNP Paribas has shown asset-based lending to be capable of being executed at pace, delivering a lower cost of capital to businesses without being unduly weighed down by unnecessary due diligence or operational requirements. At a time when banks are finding it harder to get deals agreed to and approved due to stricter regulation and increased competition from direct lenders, asset-based lending is a compelling alternative that can serve larger customers and offer greater flexibility.

For more on the ABL market in the UK, check out episode 61 of the ABF Journal Podcast