Looking at the Financing Landscape In the Year Ahead - and Beyond

Though we are now nearly four years past the official end of the Great Recession, obtaining credit remains challenging for many small and mid-sized businesses. This is especially true for businesses that have experienced difficulties such as a drop in revenue, or those with inadequate capital structure to support their cash flow.

Companies like these often find that their financing options are limited, especially within the realm of traditional bank financing. In fact, many small and mid-sized businesses have simply given up trying to obtain financing. In a recent survey conducted among business owners and executives by Forbes Insights and CIT, only 11 percent of respondents said they had sought new lines of credit or small business financing over the past year in an effort to help improve their cash flow.

Asset-based Lending as an Alternative

In these circumstances, many owners often find that alternative and non-bank financing options can help them obtain the capital they need to keep the gears of their business running smoothly. Asset-based lending (or ABL) is one of these non-bank alternatives.

ABL involves the leveraging of current assets — typically accounts receivable, inventory and/or equipment. Lenders will provide the business owner with a format for the lender to track the assets it is lending against to provide some liquidity to the borrower from those assets on a revolver basis. Smaller transactions or those deemed higher risk will usually accomplish this through a factoring facility, which involves more controls for the lender to monitor.

Factoring is the outright purchase of a business’ outstanding accounts receivable by a commercial finance company, or “factor.” Typically, the factor will advance the business between 70 and 90 percent of the value of the receivable at the time of purchase; the balance, less the factoring fee, is released when the invoice is collected. The factoring fee — which is based on the total face value of the invoice, not the percentage advanced — typically ranges from 1.5-5.5 percent, depending on such credit criteria as the credit quality of the borrower’s customers, the size of the facility and the average number of days the funds are in use.

Under a factoring contract, the business can usually pick and choose which invoices to sell to the factor — it’s typically not an all-or-nothing scenario. Once the invoices are purchased, the factor manages the receivable until it is paid. The factor will essentially become the business’ defacto credit manager and A/R department, performing credit checks, analyzing credit reports, and mailing and documenting invoices and payments.

A/R financing is more like a traditional bank loan, but with some key differences. While bank loans may be secured by different kinds of collateral (including plant and equipment, real estate and/or the personal assets of the business owner), the size of the facility is usually predicated on the cash flow coverage the income statement generates. A/R financing or ABL facilities are structured against the current assets of the balance sheet. This may involve A/R only or it may also include inventory and/or equipment — it varies from lender to lender. 

Under an A/R financing arrangement, a borrowing base of 70 to 90 percent of the qualified receivables is established at each draw against which the business can borrow money. In addition to interest being charged against the funds advanced, there is usually some sort of collateral monitoring fee or management fee that is charged — again, this will vary by lender. In order to count toward the borrowing base, the accounts receivable typically must meet an eligibility formula that the finance company tracks. Other conditions will also apply as it pertains to inventory and equipment.

Both factoring and A/R financing are usually considered to be transitional sources of financing that can carry a business through a time when it does not qualify for traditional bank financing. After a period typically ranging from 12-24 months, companies are often able to work through their circumstances and become bankable once again.

In some industries, though, companies rely on ABL as a permanent source of financing. Trucking, apparel manufacturing, import/export distribution and many service industries rely heavily on ABL as their primary financing vehicle.

ABL is On the Rise

Statistics underscore the fact that, while many businesses are finding it harder to obtain traditional bank financing, asset-based lending is trending up. According to the FDIC, the overall volume of small business loans has been shrinking since 2008 and was recently down 15 percent from its peak. The total number of outstanding small business loans (about 1.5 million) is the smallest since 1999, according to the FDIC.

On the flip side, the most recent Asset-Based Lending Index, which is published quarterly by the Commercial Finance Association, reveals that total committed asset-based credit lines were up by 2 percent in the fourth quarter of 2012 compared to the previous quarter, and total credit commitments were 6.7 percent higher than a year earlier. In addition, the majority of asset-based lenders reported an increase in total committed credit lines.

Meanwhile, new credit commitments originated by asset-based lenders in the fourth quarter were up 6.6 percent, and 55 percent of asset-based lenders reported an increase in credit commitments in the fourth quarter.

“As we have maintained throughout the recession and credit crisis, asset-based lenders will continue to lead the way as a primary source of working and growth capital for U.S. businesses as the economy hopefully moves in a positive direction,” notes Brian Cove, the CFA’s Chief Operating Officer.