If manufacturers are thinking of using ABL as a way to raise finance, or they are about to re-finance or re-negotiate an existing ABL facility, what should they be focusing on when the term sheet or offer letter from the bank lands in their inbox?
WHAT IS ABL?
Most lending decisions will take into account (to a greater or lesser degree) the value of the manufacturer’s assets, but Asset Based Lending (“ABL”) focuses on generating funds from four key asset classes, which can be combined to produce a “borrowing base”:
- Plant & machinery (“P&M”)
- Real estate
By applying a formula or advance rate to the relevant assets ( e.g. 75% of the liquidation value of the stock) the funder can provide a revolving working capital facility.
Not all of these asset classes are relevant for every business, or will necessarily be attractive to a funder, but ABL facilities generally combine invoice finance – as the core product – with at least one other asset class.
Eligibility – Not all assets are funded. Typically an ABL facility agreement will identify classes of eligible assets, and various exceptions. Most of the exceptions are well- understood but some may inadvertently take a portion of
your assets outside of the calculation if they are not tailored. Funders will also typically require the discretion to designate other classes of asset as ineligible in the future – this could reduce your available funding and would go to the question of commitment.
Covenants – There will likely be asset-specific covenants, such as “debt turn” (how long on average it takes debtors to pay invoices) or ratios of the value of the assets to the amount of outstanding funding. The key with the asset covenants is firstly to ensure they are properly tailored to your business and secondly to understand the effect of breaching them – ideally, the consequence should be an objectively determined reduction in availability, rather than a termination of the whole facility. ABL funders will often also ask for similar whole- business financial covenants to the traditional bank funders e.g. measuring EBITDA, and will try to resist arguments that they don’t need these covenants because they are protected by the assets.
One of the advantages of ABL for manufacturers can be that there is often a lower cost of capital for the funder, meaning cheaper pricing than comparable working capital facilities.
Financial reporting – There is no question that ABL facilities carry a greater administrative burden in terms of reporting than traditional term debt or RCF structures. The ABL product only works if comprehensive asset information is provided on at least a weekly basis. You need to ensure that your accounts team understands this, knows what is required, and can deliver ‘clean’ information on-time. But you might also be able to tailor what needs to be provided based upon your projected usage of the facility.
Documentation – There is usually a choice: use the funder’s standard form documents for speed and lower legal costs, but accept that these documents are not negotiable and usually unreasonable, or switch to longer-form documents and negotiate in full. Note that there is no Loan Market Association template for ABL transactions, so it can be more difficult to be confident that you have market standard terms without taking specialist advice.
Commitment – This is the biggest issue of all. Is the facility which you are being offered “committed”, i.e. once you satisfy any conditions stipulated in the agreement, is the funder then obliged to advance the funding whenever you request it? This is not a straightforward question in ABL facilities (contrast an RCF) where funders will try to retain certain discretions which might reduce the amount which you are able to borrow. For the funder, this is partly a question of managing their credit exposure (they are effectively agreeing on day one to fund assets which do not then exist) but also a question of pricing: committed facilities carry a greater cost of capital than uncommitted facilities.
In the early years of the invoice discounting/factoring industry in the UK, ABL gained something of a reputation for being used as funding of “last resort”. There were too many deals done with an expectation that the business would fail and the goal was to make money on the recovery/ exit fees, but that’s old news. ABL is now a sophisticated, large-ticket product which is competing with other debt packages for both domestic and cross-border deals.