Are You Having a Credit Crisis? Consider Asset-Based Lending. (Financial Management)

By Einhorn, Walter | Strategic Finance, July 2002 | Go to article overview

Are You Having a Credit Crisis? Consider Asset-Based Lending. (Financial Management)


Einhorn, Walter, Strategic Finance


BANKS continue to be in a mode of tightening their traditional lending policies, and auditors are more aggressive in searching financial statements for red flags. In this environment, corporate finance and accounting professionals can help their companies identify an alternative money supply source: asset-based lending.

When cash flow problems develop and business issues require financial statement disclosure in footnotes, they are automatic red flags. Resultant investigations from creditors, shareholders, and vendors could cause financial distress for the company. Vendors can modify or withhold credit to purchase merchandise. Creditors may terminate loans or lines of credit.

Financial managers can be proactive in working with their company to develop strategies and business plans and to assist in the company's preparation of formal presentations explaining how the company intends to restructure a business. These plans often tell the creditors when and how the obligations will be paid. But what can you do when your company has cash flow problems or faces a funding crisis? Suppose your corporate banker asks you to find financing elsewhere? You may feel the pressure of not having the capital available to manage the business. This is why it makes good business sense to establish an alternative relationship before the company reaches the point of financial distress.

FUNDING FORMULA

Asset-based lending isn't a new option for companies seeking funds, yet it's often overlooked. One reason corporate managers have reservations about asset-based lending is the perceived high price, or "nontraditional" format, of the funding. This lending arrangement allows a company to maintain the same ownership share in the business, and there are no new equity holders to contend with. The financing to the undercapitalized company utilizes the borrower's assets as funding collateral.

Asset-based lending contributes a significant portion of the funds necessary to operate thousands of companies across the nation. In fact, the Commercial Finance Association estimates that more than 24% of all outstanding loans are short-term loans from asset-based lenders. For the most part, asset-based loans are sophisticated credits that are secured by collateral, requiring more than normal policing and monitoring.

The asset-based loan is a specialized method of structured working capital commercial lending. In asset-based lending, the borrower may not have the capacity to service debt from cash flow. The loan's purpose is to safely finance the current business of the borrower. Sometimes businesses use asset-based lending during their entire business life, while others use it periodically or during times of difficulty. Asset-based loans can also be used as a business growth tool. If a company needs an infusion of cash to hire more employees, purchase needed equipment or supplies, or to bid on contracts, short-term asset-based loans can be a perfect solution. The ownership need not be diluted for growth purposes.

An asset-based loan is repaid in a number of ways, including cash flow generated by business success, constant rollover of working assets, recapitalization of the borrower, merger or acquisition, refunding by another lender, downsizing through asset disposition, or liquidation of assets. The lending format instills cash flow discipline that most borrowers continue to use after they solve their financial dilemma. The asset-based loan is provided against collateral such as accounts receivable, inventory, general and specific intangible assets, real estate, machinery, and equipment.

HOW IT WORKS

Many asset-based lenders provide loans in amounts from a few thousand dollars to hundreds of millions of dollars. They try to specialize in loan amounts and in asset type loaned upon. For example, a syndicate of lenders frequently finances larger asset-based loans to reduce risk exposure and to provide greater amounts of funds to companies that need large cash infusions. …

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