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Asset-Based Financing: An Alternative to Traditional Financing

Traditional banking facilities have always been based on the capacity of entrepreneurs to maintain profitability, which is measured by financial ratios. The assets of the company support margin working-capital loans, commonly known as the bank line of credit. Banks measure the borrowing capacity of the company by using various formulas such as 75% on accounts receivable less than 90 days from invoice date or 50% on raw materials and finished goods inventory, limited to a maximum amount.

The advantage of this form of financing is that it requires basic reporting to the bank. Monthly financial statements and accounts receivable listings are normally provided 20 days after month end to the bank account manager. The set line of credit is usually negotiated for a one-year term and is renewable upon the submission of year-end statements and projections.

The major disadvantage of this form of financing is that if the company is expanding very quickly, its capitalization will not sufficiently support the growth and maintain the required banking ratios. Management may be required to make difficult decisions - either diluting the shareholding by seeking additional shareholders to invest in the company or simply putting the growth on hold and losing opportunities.

“Asset-Based Financing” (ABF) not only promotes growth, but also allows management to recover advances made to the company, since the ratio requirements are almost non-existent. ABF is strictly based on the quality of the assets given as collateral. Since there is more monitoring of the collateral (i.e. inventory appraisals, external quarterly financial reviews), the asset-based lender will considerably increase the lending availability on both accounts receivable and inventory.

Normally the line of credit is adjusted weekly, pending submission of accounts receivable and inventory listings. The availability is immediately increased should large sales or inventory received from suppliers be reported. Financing requirements are based on the projected needs of the company. If the accounts receivable and inventory are available, the line of credit will increase accordingly. Usually the financing on receivables will be boosted to 85% or 90% and the inventory will be subject to an external evaluation that generally leads to an increased cap on inventory.

ABF is relatively new on the Canadian market, but is very popular in the U.S. More than 40% of all financing transactions in the American market are done via an asset-based lender, versus less than 10% in Canada.

Contact Patrick Sullivan for more information about ABF and other financing vehicles.