Asset-based loans are usually written on receivables and inventory, and lenders screen the books extensively to decide which receivables are eligible for the “borrowing base,” says Kaplan. Concentration (more than 20% of sales with one customer), dilution (a high percentage of returns and chargebacks), and aging can all lower the dollar amount the lender is willing to advance. Government and foreign receivables often won’t qualify at all. The lender will also demand that borrowers provide robust weekly reporting on portfolio trends. While the pure cost of money is relatively low, there is also a facility fee, a collateral monitoring fee, and costs for field examinations by the lender.
But many companies like the discipline an asset-based loan brings to receivables management and collections, and the certainty of timely cash flows. “Our lender sets credit limits on every customer and ensures we have proper documentation in the invoicing process,” says Jim Castille, president of New Century Fabricators, a manufacturer serving oil and gas companies. Castille has grown his business from $8 million to $30 million in four years by using an asset-based loan to fund the company’s large, project-based payroll obligations.
The company’s engagements, such as building living quarters for offshore-drilling platforms, extend over long periods, and during the long march toward completion Castille needs cash to pay his workers. “If not for the loan, I would have to find more-expensive means of raising capital — like bringing in equity,” he says.
Mix and Match
Factoring is more expensive than asset-based lending, but for companies with only a few large customers and either a lot of debt or little to no capacity to manage complex receivables, it can be invaluable. Start-ups in particular use factoring because factors evaluate clients on the strength and solvency of their customers, which are often more creditworthy than the borrowing company. The borrower sells the receivables to the factor without recourse, and the factor performs credit investigations on customers, collects the cash, and takes the loss if a customer can’t pay. “They do all the things that go into running a credit department,” says First Capital’s Kiefer. So, although the cost of factoring is higher, the borrower also reduces the overhead that comes with a credit operation.
It is now possible to combine elements of an asset-based loan and a factor. Pure Earth, a recycling and waste-management company, terminated its shrinking line of credit with a big bank this past February and secured a $5 million hybrid asset-based/factor facility.
The lender buys Pure Earth’s receivables and puts a line of credit equal to 85% of the receivables at the company’s disposal. There are no financial covenants or onerous reporting requirements and fewer “ineligible” categories for receivables, says Brent Kopenhaver, Pure Earth’s CFO. But the lender does have recourse — it can kick back an invoice to Pure Earth if it’s not paid within 90 days. The lender/factor also has the right to accept or reject new customers. And, unlike in an ABL, the lender fully discloses the relationship to Pure Earth’s customers.