Working Capital Financing – Why Asset Based Lines of Credit Work

How can Canadian business owners and financial managers secure working capital financing and cash flow financing for their businesses when obtaining business financing seems to be a major challenge?

The answer is that there exists a potentially credible solution called an “asset-based line of credit”, otherwise we call it a “working capital facility”. What is this type of financing new to Canada and more importantly – how does it work and what are the benefits and risks?

While asset-based lenders tend to be specialized independent financial firms, many in the business world are surprised to find that deep within a handful of Canadian banks there exist small, somewhat boutique divisions that specialize in asset-based lending. Ironically, they have repeatedly competed with their counterparts in more traditional commercial company banking.

The most active assets financed by these companies tend to be ongoing receivables and inventory, but in many cases, with expert advisors or partners, you can construct a facility that also includes equipment and a portion of real estate.

In general, a good way to think about an asset-based line of credit is for a temporary period (typically a year or so in our experience) that allows you to increase your margin and get higher advances on accounts receivable and inventory. This translates into more cash flow and working capital.

One of the main attractions of an asset-based lending facility (known to insiders as an ABL facility) is that your company’s overall credit quality plays the biggest role in determining whether you can be approved for this type of financing. As the name suggests, financing is on your “assets”! Not really looking at debt-to-equity ratios, cash flow coverage ratios, loan covenants and external collateral. Business owners who borrow from Canadian chartered banks on an operating or term loan basis are of course very familiar with these terms – in some respects we might call them “restrictions”

Most lawyers and accountants will tell you that, in reality, any type of business borrowing should only be undertaken with a respected, trusted and reliable business finance advisor who can guide you through the hurdles and pitfalls of any business financing arrangement. Mistakes in business financing can lead to long-term negative consequences, such as being locked into a facility, giving up too much collateral, or being locked into pricing that is not commensurate with your overall asset and credit quality.

What are the key issues you should consider when considering such financing vehicles? They are mainly:

– Advance payment rates for each asset class (Accounts Receivable, Inventory/Equipment)

– How pricing is defined (asset based lines of credit and ABL loans are usually more generous in overall facility size, but you should make sure you only pay for what you use

– Contractual Obligations – In a perfect world (and we know it’s not!) you should be concerned with the ability to pay at any time, or at least some form of nominal breakage fee

– Ensure that asset-based lending vehicles, which are often more costly, will allow you to maintain or focus on profitability; we spent a lot of time with clients exploring several different strategies to defer the additional cost of the Abl facility

So what’s the bottom line. As always, it’s simple – consider asset-based loans and ABL facilities as solid alternatives for financing your business. Work with a trusted advisor as this type of financing is often unknown or lesser known in Canada. Build your facility around what’s best for your company and reap the benefits. This is solid business financing sense.

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