Since its launch in the UK over 20 years ago, ABL has developed into a mature funding solution that can support businesses in a wide range of scenarios. Jon Roden looks at the value of this flexible funding option.
In the current environment, businesses need to be able to react to rapid changes in their operating environment. Asset based lending (ABL) can offer a straightforward and flexible funding solution. Let's look at some of the fundamentals that should be taken into account when navigating the credit process.
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Technically, ABL covers any funding secured against the specific assets of a borrower. However, in the mid-market, the main focus of ABL is on revolving facilities secured against accounts receivable (often referred to as 'invoice finance'), inventory, and plant and machinery.
ABL can be an effective way to unlock balance sheet value and boost liquidity, as well as complementing other funding solutions, such as mortgages and cash flow loans. However, it's important to consider ABL funding in the context of your company’s overall debt structure.
ABL funding is offered by a wide range of funders, meaning that a single institution can often deliver all of the debt products you need. That said, you may want to have ABL facilities and other forms of debt provided by different funders in order to secure the best-possible pricing.
Regardless of which party provides the various elements of your debt structure, it's vital to ensure each element within the structure is being used for an appropriate purpose.
ABL is designed to help fund working capital, providing temporary liquidity at different points of the cycle. As such, working capital funding is not an appropriate source of funding for capital projects and should not be used to repay term debt facilities.
When considering ABL as a funding solution, you should also be mindful that, if the asset base reduces and available funding falls, your company may find itself experiencing liquidity issues if cash receipts have been used for a purpose other than short-term working capital funding.
The main purpose of an ABL facility is to reduce working capital lock-up by advancing a percentage of an asset’s value to the borrower. However, a borrower will typically receive less funding than is implied by the headline advance rate.
It's important for a borrower to understand the formula used to calculate ABL funding availability, as a lender will typically apply reserves or make deductions from the gross ledger before applying the advance rate.
When a business is cash-positive, these restrictions are often overlooked, with many unaware of their existence and unconcerned that the effective rate is some way short of the contracted advance rate. However, at times of increased cash pressure, businesses will look to their ABL facilities and try to understand why it's not operating as effectively as expected.
To optimise the usage of the facility and to get closer to the headline advance rate, it's crucial that the business has a good understanding of the funding formula and how the actions of those working within organisations can influence the level of funds available to them.
After the challenges of 2020, companies and their management teams continue to explore funding options as the effects of the economic downturn stretch into 2021 and the end of various government support schemes come into view over the coming months.
There are certain fundamental points to consider if a business is seeking flexibility, forbearance or new money from an ABL funder.
With all that has happened in the last year, the immediacy of requests for additional funding has been understandable.
While urgent requests are sometimes unavoidable, lenders will generally not appreciate being brought into the loop late in the day. Ensuring, as far as possible, that any request is made well ahead of any cash pinch-points to enable the lender to properly consider the merits of any proposal is essential.
Articulating a clear strategic plan supported by robust financial and operational data is an integral component of any credit decision. And ensuring that information, such as financial forecasts, are clearly presented with logical underpinning assumptions makes the decision makers’ life much easier.
As businesses seek to capitalise on opportunities after the disruption of the last year, it's more relevant than ever for management teams to consider more than one scenario and understand how risks might affect the business and its ability to support an increased level of debt.
Lenders will understand health warnings attaching to forecasts, but they will want to understand upside opportunity and downside risk how this may impact their lending position. This understanding will also need to be spread, as the implementation of any business plan is likely to rely on the engagement and agreement of a number of stakeholders including other lenders, pension schemes and customers.
If your business is heavily reliant on any particular stakeholder - especially those that could potentially derail any plans – it's critical to be able to demonstrate that you have engaged them, that they understand what you are trying to achieve and that they are ultimately supportive.
While the easiest and most-logical place to seek support from is often an existing lender, they are unlikely to be the only source of support available. Exploring other potential options, especially those that are within management’s control, will give lenders confidence that they are not the only stakeholder being asked to put their hand in their pockets.
In the same vein, ensuring cash leakage is kept to a minimum will help to demonstrate that management is tightening its belt.
Does your management team have a clear appreciation and deep understanding of the business and the challenges it faces? Could it talk through how their proposal will be implemented, and point to a track record of delivering against an agreed plan? If the answer is 'no', you are at a distinct disadvantage.
Demonstrating that the senior team is engaged and has a credible plan is crucial as, without this, it's unlikely that your ABL request will get much traction.
When engaging with lenders for new or additional support, an experienced and respected advisor can be a valuable resource, providing input into strategy, planning, governance and financial reporting. All of which are important contributory factors in the credit decision.
Demonstrating that your plan has been stress tested by someone outside of the business adds to the overall credibility of the proposal, especially when the third party is known to your lender.
In the right circumstances, ABL provides a dynamic, flexible funding solution that is able to meet the demands of businesses in the current economic environment. However, even where a business is well placed to take advantage of ABL, it's important that those early engagements with the funder are managed appropriately.
Ensuring the management team understands the key components of the funding formula is critical to optimising facility usage and cash release to working capital.
Our ABL Advisory Team has specialist knowledge and a track record of working with companies and lenders to secure new ABL facilities for businesses of all sizes across a variety of sectors. Working collaboratively with management teams we provide a range of services, including refinancing, raising new finance, pre-lend reviews, lender negotiations, benchmarking and data analytics.
For support with your ABL funding, get in touch with our team.
