Asset-based lending is a versatile and attractive option for companies experiencing everything from rapid growth to inconsistent earnings, which has only been magnified by the COVID-19 pandemic. Brent Hazzard, head of asset-based lending and asset finance at Citizens Bank, outlines why ABL matters now more than ever.

Asset-Based Lending at a Glance

• As the economy improves, asset-based lending is an efficient way to access funding for growth and acquisitions.
• These loans have a more flexible structure than cash-flow business loans and are more competitively priced.
• An asset-based loan is a suitable lifecycle lending option for many companies, including retailers, manufacturers, wholesalers, staffing firms, distribution companies and transportation and logistics companies
• Finding the right lender is the key to unlocking ABL benefits.

Many companies rely on asset-based lending to manage the ups and downs of the economic cycle and the COVID-19 pandemic has shown once again how flexible and valuable this source of funding is. As economies shut down and corporate cash flows dried up, businesses could still turn to ABL for much needed working capital, whether it was to keep the lights on or to make more strategic moves. Now, with economies starting to come alive again, businesses can use these same ABL facilities to respond to increasing customer demand, ramp up operations and take advantage of better economic times.

While ABL activity continued during the pandemic, the market definitely took a hit. In 2020, ABL volume totaled just $72.4 billion in the U.S., the lowest since 2010, according to data from Refinitiv. The industry’s rebound is already under way, however. In Q1/21, ABL volume totaled $26.7 billion, up 67% from Q1/20, according to Refinitiv ABL quarterly data. In light of this turnaround and ABL’s potential to help companies capture near-term growth opportunities, it’s worth reviewing the nuts and bolts of these credit facilities.

How ABL Works

ABL entails lending against the value of a company’s assets. Usually, those assets are inventory and accounts receivables, and less commonly, intellectual property (a company’s brand, for example) or fixed assets such as the machinery on a shop floor. The more confident lenders are in a company’s underlying value, the greater advance rate they will be willing to provide — often as high as 85% to 90% of the net orderly liquidation value (NOLV) of the assets.

ABL lenders monitor the value of the assets over time since the value will vary depending on a company’s sales, collections and production. As the asset values expand, the borrowing capacity on the secured facility increases. Likewise, as the asset values decrease, additional monitoring may be necessary, especially when pre-defined thresholds are broken.

Therein lies the flexibility of ABL facilities: The lending parameters are set at the outset, while the value of the assets determines the maximum borrowing capacity and reporting requirements. This structure makes asset-based lending attractive to companies with rapid growth, inconsistent earnings, seasonality and cyclicality. In other words, it is a good choice for lifecycle lending. ABL facilities are particularly popular among companies with large inventories, such as retailers, manufacturers, wholesalers and distribution companies.

Common ABL Uses

The most common use of ABL is for working capital. A seasonal business might use the funds to build up inventory, while another may use it to buy new equipment or launch a new product line. Some companies choose to put an ABL facility in place and have the funds easily accessible in the event of an unexpected opportunity.

ABL also is utilized for more sophisticated financing purposes. Besides working capital, ABL also can be used as part of acquisition financing. If a company already has business cash-flow loans in place but needs more capital for a purchase, it can use an ABL to ratchet up the borrowing and gain additional leverage. As long as the ABL lender is confident in the borrower’s underlying assets, it will not be overly concerned about leverage. Banks are already seeing an uptick in customers lining up ABL for acquisition financing — a trend that’s likely to continue in 2021 as the economy starts to heat up.

The third major use for ABL is for a dividend recapitalization, wherein companies use funds to make a special payment to an owner or shareholder who is retiring or cashing out of the business. In this case, the cash is leaving the business and not being reinvested, so a lender may be especially vigilant to ensure that plenty of excess liquidity remains (at least 15%-20%) for the company to continue to provide sufficient working capital.

Benefits of ABL

To understand the benefits of ABL, it’s helpful to contrast these loans with traditional cash-flow business loans. A big difference is cash-flow loans typically come with various covenants that require a borrower to fulfill certain financial conditions or limit a borrower from taking certain actions. Some examples of financial covenants include maintaining a certain leverage ratio, interest-coverage ratio or minimum free cash flow. Meanwhile, the covenants might restrict a dividend recap or force a company to seek a waiver or amendment to make an acquisition.

ABL facilities, on the other hand, typically have only one covenant triggered by a borrower’s liquidity (normally, to keep excess liquidity at 10% to 15%). While operating within that covenant, borrowers are generally free to use the capital as they see fit. This flexibility comes with an additional requirement, however. ABL reporting is a bit more rigorous in terms of its frequency. A company needs to report on its collateral on a monthly basis to the bank. This means in order to qualify for an ABL facility, a company needs the systems and processes in place to keep a close accounting of its inventory or A/R.

As noted earlier, ABL is also a way to gain additional leverage. Companies and private equity sponsors often use this additional leverage for acquisitions or simply as a way to access more working capital easily and as needed to grow a business.

Finally, ABLs are competitively priced. In today’s environment, an ABL could easily be priced 80 to more than 200 basis points below a comparable cash-flow loan.

Finding an Asset-Based Lender

First and foremost, a company looking for an ABL lender will want one that understands its business, including the specific product or service it offers. This knowledge helps to properly value the inventory and A/R and also means the lender can act as an advisor to help grow the business. For example, a bank with sector expertise might have insights on possible acquisition candidates.

A company should also look for lenders with experience in ABL. Banks will typically hold asset-based loans starting at approximately $5 million. However, if the size of the ABL facility approaches $75 million or more, the loan is often syndicated among several banks. This is when ABL experience is critical, since the lead bank must organize the syndicate financing. Through this process, an experienced ABL lender can assemble and scale the bank group necessary to assist with a company’s borrowing needs. This will enable the lender to fund the operations, grow the business or finance an acquisition.

ABL is widely recognized as a good option for lifecycle lending, given its ability to fund companies through the peaks and troughs of the economic cycle for everything from operations to acquisitions. Indeed, even though ABL slowed in the darkest days of the pandemic, activity quickly began to rebound by the end of 2020. Now, as the economy comes back to life, these companies are in an excellent position to seize new opportunities.

Key Takeaways

• With the economy improving, companies looking to access growth capital for operations or to make acquisitions should consider ABL.
• An ABL is a senior secured loan with a borrowing limit based on a percentage of the net orderly liquidation value (NOLV) of the company’s assets, usually A/R and inventory.
• ABLs have a flexible structure, typically with only one covenant tied to liquidity, and are an efficient way to increase leverage.
• Companies experiencing rapid growth, inconsistent earnings, seasonality, cyclicality and large inventories should consider ABL.
• It’s important for a company to choose a lender familiar with its industry and products or services and use a lead bank with syndication experience for ABL facilities that exceed $75 million.

Brent Hazzard heads Citizens Bank asset-based lending, asset finance and transitional finance teams. He has more than 30 years of experience as a lender.