Manufacturing companies experiencing stress can suddenly find themselves in the market for an Asset Based Lending product (ABL). This strategy is usually employed to replace an existing Bank Lending Relationship. It is important to realize most of these situations have not developed overnight, so it is important for companies to react swiftly to fix problems before things get this far.
Most commonly, an ABL Lender is being considered because cash flow has gotten tight, the terms of an existing bank relationship have been violated, or the existing bank is not willing to extend its relationship beyond current commitments. Most small to mid-sized businesses have little or no experience in this realm as there are a number of things to consider outside of an interest rate. Special attention needs be paid to all of the details of not only the loan structure/terms, but also with the details associated with the information the Company will provide as part of its request for financing.
Asset Based Lending, leveraged correctly, can be an excellent tool for small to mid-sized businesses with past financial struggles that no longer qualify for bank financing, are experiencing rapid growth, have financing needs beyond the capability of a traditional bank or do not want to dilute/further dilute ownership. Here at SEWN, we have plenty of experience with these situations and can get a PA manufacturing company on track with a proper strategy.
Here are some things to consider when evaluating an ABL Lender:
Know what collateral values the lender will be basing its advance rates on. Determine whether it’s Fair Market Value, Orderly Liquidation or Forced Liquidation. A lender should be able to disclose this up front.
Advance rates on Accounts Receivable (AR) are typically from 75% and up on AR <90 days due. Typically, a cross age rule of 10-25% is applied. AR must be of job completion in nature and fully due and payable.
Identify the existence of any ratios in terms of the Lender’s exposure on specific collateral that could impact credit availability. For example, a lender may be willing to advance up to 50% of the net orderly liquidation value of inventory, but may cap its exposure there to not exceed 50% of its exposure of AR at any given time.
In addition to an interest rate, frequently, there is a collateral management fee/service charge. Pay attention as to how this is applied. Most commonly, it is assessed on the average outstanding loan balance, but sometimes it can be assessed on specific collateral values, not what is borrowed, which should be avoided.
Float days should be no more than 2-3 days.
If an Intermediary is involved in a deal, the lender only should be compensating that individual and it should be clearly stated as to what that compensation entails.
Contractual periods usually are 2-3 years. Pre-payment penalties are common and are usually 3%-2%-1% or 2%-1% of the committed amount.
On a 2-3-year contract, it is not out of the ordinary to encounter an annual renewal fee. These usually can be anywhere up to 1% of the committed loan amount.
Minimum usage requirements and unused portion fees are a fact of life, these levels need to be realistic.
Validity Guarantees and Work Through Agreements commonly replace Personal Guarantees in these deals; however, a Personal Guarantee requirement can still be a possibility depending upon the nature of the transaction and the Lender.
Borrower is responsible for all costs associated with a pre-funding field examination and any required appraisals.
A Lender will want to use its own appraisal company, so a Borrower should not attempt to do this on their own or expect to be able to use an existing appraisal (sometimes permitted).
Draws are usually accomplished by Wire or ACH, the Borrower is responsible for these costs.
All AR proceeds go to the Lender. This is usually accomplished using a Lockbox or Blocked Account. The Borrower is responsible for any associated costs.
Quarterly, Semi-Annual and Annual Audits are a possibility depending upon the nature of a deal and the sophistication of a Lender. A fee will most likely be charged for this service.
Success Fees should be avoided.
There is a chance that money can be invested into a transaction that never funds. It is important that a company be very thorough in its presentation as anything withheld will surely come out in a pre-funding field examination.
Head spinning yet?
There is a lot to consider when looking at this type of financing, let alone, trying to calculate its actual all-in cost. If you’re a business or know a business that could use some help with this type situation, or with any of the other challenges, contact SEWN. Our service costs are covered through partner funding sources and completely confidential.