Using Short-term Debt to Meet Long-term Needs

This post originally appeared on the NIST MEP Blog

Stretching your businesses working capital through various types of short-term debt instruments can be a good solution to finding the cash to fund revenue-generating marketing programs or help your company manage when clients don’t pay bills on time. Some of these short-term debt products may be particularly useful to business owners who may be discouraged by current bank lending practices.  Manufacturing companies are increasingly using a product, commonly referred to as Asset Based lending as an alternative to bank loans.

What is Asset Based Lending (ABL)

Asset based loans are based on a borrower’s short term assets that are used as collateral to gain cash from a lender right now.

Asset-based lenders typically advance funds against a company’s accounts receivable, inventory, or equipment.   The amount of funds that are advanced through a revolving line of credit is dependent on the agreed percentage of the value of the secured assets, e.g. 70 percent to 80 percent of eligible receivables or 50 percent of finished inventory. The term eligible receivables refers to the receivables deemed by the lender to be the highest quality (i.e. collectable in less than 60 days from customers with strong credit ratings). Conversely, receivables from individuals or small companies that pay later typically will not be considered as eligible for loan advances due to the perceived higher risks levels.

How to Get Asset Based Financing

There is a wide range of organizations that offer ABL products, from banks to many independent finance companies. The Commercial Finance Association maintains a BizCapNet website that can be used to search for ABL providers. For smaller companies, the key requirement may be to find lenders interested in making relatively small loans (e.g. less than $500,000.) Larger banks prefer to make larger loans because the cost to the bank of monitoring an asset-backed loan is generally the same whether large or small. Larger banks also typically ask company owners to provide personal guarantees and may require the company to transfer all other banking relationships over to the bank.

Pros

• Asset based loans can provide a much needed source of cash for companies that are rapidly growing, and may have existing debt.
• The borrower can draw down funds when needed to get over financial bumps or to sustain growing sales.
• These loans are particularly suited to manufacturers with existing debt, seasonal needs, or industry cycles that strain cash flow.

Cons

• The ability to secure a line of credit through ABL depends on the quality of the receivables. Receivables from customers that typically pay in more than 60 days will not be eligible as collateral for a cash advance.
• Asset-based loans can cost more than traditional loans. Some organizations will add an ‘audit’ and due diligence fee to the overall cost of the loan.
• Larger lenders may restrict eligibility for asset-based loans to companies that handle all their banking needs with them.

In short, an asset-based loan is not a silver bullet to current bank lending practices. There are different costs associated with the benefits. But if your company finds itself temporarily strapped for cash to meet critical financial needs—e.g. enough cash to fund revenue generating-marketing programs, better management of seasonal or inconsistent cash flow, or short term coverage of expenses when customers are slow to pay invoices, ABL may be a viable option to achieve growth goals and to meet financial commitments.