Asset-Based Loans Can Offer Attractive Financing Option

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by Glenn Burroughs

How can companies maximize their financing options right now when credit is tighter than ever? This is a question on the minds of middle-market companies across the Puget Sound region and beyond.

Businesses need money to grow, and acquiring owners often want leveraged returns based on minimal equity investment. Loan size is often the most important factor when selecting a senior lender to finance growth or an acquisition.

A cash flow structure measures loan size as a multiple of the company’s cash flow or earnings before interest, taxes, depreciation and amortization, commonly referred to as EBITDA. Since the company’s ability to generate profit is the primary source of repayment, cash flow financing is typically available for larger companies with revenues in excess of $25 million and a demonstrated pattern of stable profitability.

Not all companies qualify for cash flow financing. The company could be too small or have irregular or modest earnings.

Private equity funds or companies looking to finance mergers, acquisitions or leveraged buyouts may find that hybrid loan structure such as asset-based lending with an over advance term loan can be an ideal loan choice due to maximum proceeds, flexibility and a cost-competitive debt structure.

These companies can be asset rich and therefore benefit from an asset-based loan structure in which the loan is based on advances against a portion of accounts receivable, inventory, machinery and equipment and even real estate. Asset-based lenders often advance funds when traditional commercial banking or cash flow sources are not available, so the assets can serve as an additional cushion and source of repayment in a worst-case scenario.

Over advance explained

For companies seeking maximum leverage, an asset-based loan with a cash flow component — commonly known as an over advance, stretch piece or air-ball — can serve as a hybrid solution. Companies get the borrowing base leverage of an asset-based structure with the flexibility of a cash-flow solution, usually limited to a maximum of 25 percent of the total facility.

The over advance is not covered by the availability of funds provided by the assets. Rather, a lender looks at the company’s historical cash flow and availability to repay the debt.

Asset-based loan structures combined with an over advance are an excellent choice for asset-intensive acquisitions, such as manufacturers, wholesale distributors and retailers. Typically, these old economy companies are capital intensive, yet have lower gross profit margins.

Seasonal over advance

Another similar loan structure is a seasonal over advance. This approach is particularly helpful for highly seasonal businesses.

By recognizing that working capital levels build in anticipation of peak selling periods, higher advance rates for a specific period of time, such as three to four months, provide a company with greater working capital when it is most needed. The seasonal over advance is repaid once the company completes its selling season.

Thanks to its flexibility and cost-competitive debt structure, asset-based lending has become the choice for many companies in the Puget Sound area and across the country, and spanning a variety of industries.

For private equity firms or companies looking for financing for increased working capital, growth, mergers and acquisitions, recapitalization and restructurings, turnarounds, buyouts or refinance choices, an asset-based solution with an over advance can be a hybrid solution that delivers the best of both worlds — helping to unlock the value of the company’s assets and provide working capital growth.

While loan size is significant when selecting a lender, it is important to remember the importance of relationships. Your lender should take time to understand the business and find creative, flexible solutions for the company.

The company should understand the lender’s credit processes, its reputation for getting deals done and how the lender typically reacts if the business under performs.

Glenn Burroughs was Senior Vice President with PNC Business Credit at the time this article was written.  Glenn is now Senior Vice President with Key Bank Asset Based Lending.  He can be reached at or 206.684.6055.  The article was originally published on April 25, 2008 in the Puget Sound Business Journal and has been reprinted here with permission from the author.

© American City Business Journals Inc.

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