Asset-Based Lending

The Ultimate Overview of Collateral in Asset-Based Lending (ABL)

January 23, 2019

Learn how collateral is used in asset-based lending to determine your borrowing base

Asset-based lending (ABL) is a valuable financing resource for companies that have a substantial number of receivables or physical assets and are looking for a flexible type of financing. An ABL facility will typically consist of a combination of lines of credits and term loans backed by the collateral of the business. These types of lenders understand that there is no one-size-fit-all financing solution, so custom facilities will be created for each borrower.

ABL is especially beneficial to companies with uncertain or cyclic cash flows. Unlike other types of small business loans, asset-based loans are not primarily based on personal credit history or the company’s financial performance; instead, asset-based lenders look at the different components of the business that can be used as collateral. In the case of default, the collateral would be liquidated to repay the lender, which makes this secured type of financing cheaper than its unsecured counterparts.

Each type of collateral has unique characteristics and priority in the eyes of the lender. This helps to determine the total size of the credit facility, which is called the borrowing base. This guide serves to help guide a potential borrower through the different types of collateral in asset-based lending.

The primary types of collateral include:

  1. Accounts Receivable (A/R)
  2. Inventory and Raw Material
  3. Machinery
  4. Property and Real Estate

  1. Accounts Receivable (A/R)

Accounts Receivable are the preferred type of collateral for asset-based lenders. They provide both a clear picture of value and defined term of repayment which means that the lender is willing to advance the most against them. Advance rates for accounts receivable are extremely favorable and range between 80% and 90%. Borrowers should expect that the lender will require a large portion of the borrowing base to be backed by accounts receivable. The lender will require an a/r aging report but not typically the individual invoice documents which will save time and be more streamlined than factoring.

Another benefit of ABL specific to accounts receivable is that this type of lending is non-notification. Receivables that are assigned to the lending facility will not trigger a notification to the invoiced customer. Payments of these invoices will be made to a lockbox controlled by the lender and swept daily to distribute the funds. Other types of factoring typically require a notice to the customer, so borrowers enjoy the subtle nature of ABL.

A final benefit of accounts receivable is that they can be revolving within the facility. Over time, as the receivables are paid, and new invoices are issues, the amount that the borrower can utilize will change too. This flexibility is one of the key aspects of the way ABL functions.

  1. Inventory and Raw Material

The second most important type of collateral is Inventory and raw material. Lenders like these types of assets because their value is usually easy to determine and therefore easy to sell in the case of default. However, ABL does not allow for unfinished inventory to be used as collateral. Any work-in-progress assets will not be advanced against due to the difficulty of selling an unfinished product. The advance rate for inventory and raw materials is typically the lowest of all asset types around 50% but depending on the lender could be significantly higher.

Some lenders will consider inventory to be revolving in which the collateral pool, and therefore the amount advanced, will change depending on the increase or decrease in the total balance. Usually, lenders will not allow for inventory to be the majority of the collateral for the facility; due to the nature of the secured loans, accounts receivable is the most secure for the lender.

  1. Machinery

Fixed assets such as machinery, vehicles or other large equipment can be used as collateral within an ABL credit facility. Understanding the value of the equipment is critical to the advanced amount, so getting a third-party appraisal may be necessary. Unlike accounts receivable and inventory, machinery is non-revolving and therefore the advanced amount is typically structured as a term loan and will not fluctuate in value.

This loan will have a repayment schedule and will be advanced as a single lump-sum. Advance rates will vary greatly depending on the type and value of the machinery, and therefore not typically used as the primary asset in the collateral pool.

  1. Property and Real Estate

The least commonly used type of collateral in an asset-based loan are the company’s real estate holdings. Some asset-based lenders will consider the buildings, facilities, or land owned by the borrower. Appraisals of the company’s property are key to understanding the value of the potential collateral. Real estate is like machinery in that both are considered fixed assets. The advance rate on real estate can potentially be on the higher side (over 60%) and will be structured as an asset-backed term loan.

While these are the four major types of collateral used in ABL, alternative assets are sometimes considered: trademarks, intellectual property, customer lists, and other potentially valuable assets can be used in the lending facility. For asset-based lenders, a large collateral pool is the key driver for a large borrowing base that a business owner can utilize. Asset-based lending is a flexible and affordable solution for asset-rich borrowers, who can leverage their collateral to take out large financing options.