There are many ways for businesses to acquire additional capital to grow their operations, and one of these is asset-based lending or ABL.
Asset-based lending or asset-based loan (ABL) is a type of lending or loan where a debtor (or the borrower) secures or offers their assets as the collateral to the said loan acquired from a creditor (or the lending institute, or lender). In some circumstances, a business owner may have multiple assets at their disposal but has low cash flow or capital; this is where ABL comes in which is advantageous for both parties – the debtor makes use of their idle assets to acquire additional capital and the creditor is secured of the loan they provide.
ABL is different from other forms of loans since the debtor is evaluated on the value of their assets, whereas in other loans where the debtor’s creditworthiness is measured based on their credit history. Assets that may be used as security or collateral may either be:
- real properties (e.g., land, real estate) or personal properties (e.g., inventory, equipment);
- intangible properties, such as accounts receivables, intellectual property, balance sheet assets, among others.
Securities and collaterals under ABL may also be a combination of multiple assets, or a single asset, if its current value is enough to cover the amount of loan being applied for.
Let’s run a hypothetical about a business owner (or the debtor) who wants to acquire a loan in the amount of $100,000 from lender (or the creditor). This debtor has in his portfolio the following assets:
- a piece of land valued at $100,000;
- balance sheet assets valued at $175,000;
- numerous equipment valued at $150,000.
Said debtor goes to the creditor and the creditor offers to him the following loan-to-value ratios:
- real property at 75%;
- intangible property at 65%;
- personal property at 55%.
The loan-to-value ratio is the heart of ABL – this is the percentage that the creditor is willing to lend the debtor based on the latter’s properties’ value.
Thus, with the current assets of the debtor, and with the loan-to-value ratios offered by the creditor, the debtor may only acquire $75,000 if he offers the land (which is a real property) as security or collateral; $113,750 if he offers the balance sheet assets (an intangible property); or $82,500 if the equipment (considered as personal property) is offered.
In this example, the debtor would more likely use their balance sheet assets as security or collateral to their loan as this is enough to cover the $100,000 loan they want to acquire.
With the above example, valuation or appraisal of the property is also important since it may greatly affect the amount of loan that can be acquired by the debtor. Appraisal of the debtor’s property may be done by an accredited appraiser by the creditor, or the appraisal report previously completed by the debtor may be submitted subject to the approval of the creditor. Here, an asset-based lending lawyer may assist debtors with property appraisals, among many other transactions in the ABL.
Asset-based lending (ABL) may be said to be both risky and less risky, depending on the circumstances.
While ABL does not require a debtor to sell their asset/s to the creditor, since it’s only a security or collateral, there’s still that risk of losing these assets offered as a security or collateral when the debtor fails to pay the loan according to the terms and conditions of the ABL contract. Therefore, if a business owner is confident that they can faithfully pay the loan, then ABL is the best, less risky type of loan suitable for them. Accordingly, this would entail extensive financial planning and foresight on the part of the business owner or debtor.
ABL also has a shorter term of payment which may either be an advantage or a disadvantage for the debtor. This shorter term is an advantage when the debtor plans to borrow funds more quickly by establishing credit history with the creditor to increase further borrowings. However, a shorter term is a disadvantage if viewed differently since this would mean that the capital amount plus its interest is spread over just a minimum number of months, hence, each monthly payment is typically larger.
Thus, ABL being risky just depends on the goals and objectives of the debtor, along with the willingness to accept such risk or not.
Although asset-based lending (ABL) has similarities with the other types of loan or traditional lending, it is largely distinct because of how loans are approved in ABL.
Because ABL is not creditworthy-specific, it opens a lot of opportunities for debtors to borrow funds for their businesses by tailoring the needs of the debtor with the services offered by the creditor. Although these would be dependent on the array of assets that the debtor has, it would also mean that the more assets one has, the more choices and opportunities there is for the would-be debtor.
Debtors, in the process of applying for an ABL, may discover their asset’s value, especially for those which have long been idle or was already forgotten. This is especially true for real properties. In ABL, debtors would need to run through their assets’ value to also determine the possible amount they can borrow. As such, debtors get to have profiles with regards to their assets in the process which may also help them not only with ABL but for other transactions as well.
Fit for some Industries
ABL may be a perfect lending arrangement for some industries or sectors. For example, for businesses in the transportation industry especially those which transports specific goods, when these specific goods have a spike in demand depending on the season, ABL may provide for additional capital during these in-demand seasons and collateral may be charged over the numerous vehicles that that business has.
The same is true for manufacturing or production businesses which have specific demand on a specific season, such as wine and food companies whose demand may increase during the holiday season.
Comment your questions down below or talk with the best asset-based lending lawyers in Canada to find out more about asset-based lending.