Asset-based lending, and how a borrowing base is built

What asset-based lending is, in plain words

Asset-based lending is a facility sized on what the business owns rather than on a multiple of what it earns. The funder builds a borrowing base by taking each class of asset in turn, deciding how much of it it is prepared to advance against, and adding the results together. That total is the availability, and the business draws against it.

The classes are usually the same four. The debtor book comes first and does most of the work, because an invoice to a creditworthy customer turns into cash on a known timetable. Stock comes second, at a lower advance because stock is only worth what someone else will pay for it in a hurry. Plant, machinery and vehicles come next, valued on what they would fetch in an orderly sale rather than on the balance sheet figure. Property, where there is any, is the fourth.

The important difference from a term loan is that the facility is not a fixed amount. It is recalculated as the assets move, so it grows when the business grows and it shrinks when the business shrinks. That is what makes it useful and it is also the single thing buyers most often fail to plan for.

What the funder takes comfort from

Security is a debenture over the company with fixed charges over the identifiable assets and a floating charge over the rest, and in most cases the funder takes an assignment of the invoices themselves. In some structures the funder also runs the collections, in others the business keeps them and simply reports.

The comfort, though, comes from the quality of the assets and not from the charge. On the debtor book a funder is examining a short list of things, in this order.

Dilution. The gap between what is invoiced and what is eventually collected, from credit notes, rebates, discounts, disputes and write-offs. High dilution is the fastest way to a low advance rate, because it says an invoice is not what it claims to be.
Concentration. Where one customer is a large share of the ledger, the funder caps how much of that customer's debt counts, so the availability is smaller than the ledger total suggests.
Ageing. Debt beyond an agreed age drops out of the base entirely, and in many agreements the whole of a customer's balance drops out once a set proportion of it is overdue.
Contra accounts. Where a customer is also a supplier, the funder assumes the two will be set off against each other and takes that exposure out.
Contract terms. Retentions, pay-when-paid clauses, stage applications and rights of set-off in a customer's standard terms all reduce what an invoice is worth. This is why contracting businesses are assessed harder than distributors.

On stock and plant the comfort comes from an independent valuation, and the funder will send in a surveyor rather than take the accounts on trust. That inspection repeats at intervals through the life of the facility.

How it is priced and how the costs actually land

Nobody can tell you a rate before a funder has looked at the ledger. The shape of the pricing, though, is consistent, and it has more moving parts than a term loan, which is where buyers get caught.

An arrangement fee on the facility, usually deducted at the outset.
A discount charge on the money actually drawn, quoted as a margin over a reference rate. You pay this on the balance you are using, not on the facility limit.
A service or collection fee calculated on turnover rather than on borrowing, which is a separate charge from the interest and the one most often missed when the two facilities are compared.
Survey and audit fees for the periodic field examinations, charged as they occur.
A minimum fee in many agreements, so a quiet year still costs what the funder priced for.
A notice period on exit, sometimes long. Getting out of an asset-based facility is a project, not a decision, and the cost of leaving belongs in the comparison on day one.

A personal guarantee is less automatic than on cash flow lending, because the funder already holds the assets, but a warranty from the directors about the accuracy of the ledger is close to universal, and it bites where the reporting turns out to be wrong.

Where it fits in an acquisition

Asset-based lending funds a larger share of an asset-rich target than a cash flow loan will, because the borrowing base can be built out of assets the target already owns. In a management buy-out of a manufacturer, a distributor or a contracting business, it frequently does the heavy lifting that senior term debt cannot, and it is often used alongside a smaller term loan rather than instead of one.

It also has a second job after completion. The same facility that helped fund the purchase is the one that funds trading afterwards, which removes the separate working capital conversation that so often gets left until month three. Where the target owns its equipment outright, refinancing that equipment through asset finance can release cash at the same time, and the two are commonly done together. How the pieces sit in an order that lenders recognise is covered in stacking facilities.

Where the only real asset is a debtor book, the simpler and usually cheaper product is invoice finance. Asset-based lending earns its extra cost and complexity when there is stock or plant to bring into the base as well.

Who it suits, and who it does not

It suits businesses whose value is spread across the balance sheet: manufacturing, distribution, wholesale, plant-heavy trades, and businesses in electrical and M&E where a large ledger sits behind the work in progress. It suits buyers who want the facility to grow with the business rather than being resized by application every time it does.

It is a poor fit for service businesses that bill for time and hold nothing much. An accountancy practice has recurring fees and almost no assets, so the borrowing base would be close to nothing, and cash flow lending is the right conversation instead. It is also a difficult fit where the customer contracts are full of retentions and applications for payment rather than clean invoices, because each of those reduces what the ledger is worth to a funder.

And it is the wrong product for a business that wants to be left alone. Asset-based lending comes with reporting obligations, periodic inspections and a funder who will notice things. That is the trade for the extra money.

What goes wrong

The availability falls exactly when it is needed. Trade slows, the ledger shrinks, and the borrowing base shrinks with it, at the moment the business most wants the headroom. A facility that breathes with the business breathes out as well as in, and a plan that has never been tested against a bad quarter is not a plan.

The headline limit was never the real number. A facility sized on the gross ledger and drawn against the eligible ledger are two different figures, and the gap after concentration caps, ageing and contra accounts is often large. Build the base from the actual ledger before agreeing anything that depends on it.

The field examination finds the reporting is wrong. Overstated stock, invoices raised before the work was done, credit notes not put through: any of these can cut the advance rate overnight and put the directors' warranty in play.

Nobody priced the exit. A notice period and a termination fee turn a refinance into a negotiation with the incumbent, and the time to find that out is before signing, not when a better offer arrives.

Customer relationships were not thought through. Where the funder collects, your customers deal with them. Whether that matters is a commercial judgement, and it is one to make deliberately.

What a funder will want to see

An aged debtor listing and an aged creditor listing, at a recent date and reconciled to the accounts.
Dilution history: credit notes and write-offs over a meaningful period, not a single month.
The top customers by value with payment history and terms.
Standard customer contract terms, including anything about retention, set-off or payment on application.
A stock listing with ageing, and an asset register with acquisition dates and any existing finance against each item.
Three years of accounts and current management figures for the target.
The heads of terms and the buyer's own position.

Terms that appear in a facility agreement and nowhere else are explained in the glossary, and the general order a funder asks for paperwork is in the document checklist.

Getting it in front of a funder that reads the ledger properly

Asset-based funders differ from each other more than lenders in almost any other part of the market. One will take a view on work in progress that another will not touch; one is comfortable with contracting ledgers and another will discount them to nothing. Sending the same deal to the wrong one produces a small facility and the impression that the business is weaker than it is.

We know this market, and we know specific people who have built borrowing bases out of businesses like the one you are buying. You tell us what is on the balance sheet, we go to them, and we come back to you with who can fund it and what they will examine first.