One of the most important decisions a business owner will make is how to fund their business on a day to day basis. This is equally important from the start up stage right through the life of the business. Many SME businesses with insufficient equity capital will generally fund their working capital requirements via the traditional overdraft facility or debtor finance (aka invoice finance or factoring) products. This decision alone is a significant one; getting it wrong can have major negative impacts on the ability for the business owner to fund future business growth because of inadequate funding limits. An Asset Based Loan (ABL) may be the alternative solution you are looking for, this article will describe and compare with popular financial products.
So what factors should a business owner look at when considering the most effective product for funding their working capital requirements? Too many times the business owner will simply look at the cost of each of the facilities and proceed with what they perceive as the ‘cheapest facility’. Without taking into consideration other factors; this decision making process could result in the facility chosen being more costly and inefficient to the business, resulting in lost sales opportunities and an inability to take advantage of supplier discounts because of restrictive or inadequate funding limits.
The traditional overdraft generally requires security by personal assets such as the family home. When the home is tied up for business funding requirements the owner must measure the impact of having their future funding needs set around loan valuation ratios (LVR’s) determined by the current market valuation of their property. This would certainly not be suitable particularly in those instances where the business is forecasting future growth during periods which do not correlate with the property market. Your business may experience a period of significant growth when the property market is going through a correction period resulting in your overdraft limits being reduced and funding requirements exceeding any equity available in the property.
The business overdraft is a cash flow based lending facility and the withdrawal or reduction in limit may also occur when the company financials represent poor trading performance; hence, the facility may be withdrawn when the company may require it the most. Generally with this type of lend, clients will need to meet and continue to meet financial covenants relating to generating profits to meet interest coverage ratios, leverage and EBITDA multiples. Also, from the business owner’s personal perspective, putting up the family home to fund their business funding requirements can also inhibit their ability to utilise available equity in their property to increase personal net wealth opportunities through, for example, further property/equity market investments.
Flexibility of an Asset Based Loan
A major influencing factor in the funding decision should be around flexibility of the facility. An Asset Based Loan (ABL) facility is linked to the your business’ working assets (inventory and accounts receivables), consequently it will organically grow with your business as it goes through periods of sales growth. In theory, the ABL is fully repaid once the current business cycle is complete. That is, all inventory has been sold and all accounts receivables (commonly known as the cash conversion of working assets) that make up the borrowing base. It is essentially a revolving line of credit secured against the current assets of the business with repayments under the facility being available to be re-borrowed. Conceptually, an ABL facility does not require amortization, as the ABL facility is self-liquidating unlike most commercial facilities where the source repayment is cash flow from operations.
Advantages of an Asset Based Loan (ABL) facility
The ABL facility requires fewer financial covenants and thus gives you that most important flexibility. Financial covenants aimed, for instance, at controlling leverage or capital expenditures are not considered necessary for the purpose of monitoring exposure under an ABL facility and the value of the borrowing base. ABL facilities can normally be approved in a matter of days and implemented very quickly, and in most cases far quicker than implementing an overdraft with its security requirements. Another important feature of the ABL, as opposed to some debtor finance products on the market, is the fact it is not intrusive in your day to day business dealing with your customers.
The cost of an Asset Based Loan (ABL) facility
Although the total cost of an ABL facility may, in some instances, be higher on paper to the traditional overdraft, those business’ seeking flexibility and reduced security requirements for their funding requirements will see the valuable benefits are worth paying for with an ABL facility. For a growing business that needs working capital to expand it is clear that asset-based lending provides a real alternative.