Both ABL and the ways in which companies might use asset-based loans have evolved. Discover the possible advantages of this efficient, frequently less expensive financing solution by reading these four ABL Myths.
About Asset-Based Lending
An increasingly intriguing trend in corporate finance is the growing recognition of Asset-Based Lending (ABL) as a cost-effective solution for cyclical or seasonal cash flow. These are competitively priced, well-collateralized loans for big, profitable businesses.
However, long-standing myths continue to impede comprehension of ABL and, worse still, may prevent some businesses from taking into account a loan instrument that might be the best source of funding for them.
Myth: ABL is merely a last-resort loan
In actuality, ABL is really another capital markets instrument. It’s just an alternative financing strategy that prioritizes asset levels over cash flow.
An ABL might be more appropriate for a company with a high asset load, thin margins, and low EBITDA levels than it would be for one with little assets but considerable earnings. For people who have never interacted with ABL, there is still some bad connotation, but it largely depends on the character of the firm. They never took the effort to find out the true facts; they only had an instant view.
Myth: Equity sponsors don’t really like ABL
In actuality, purchase financing is frequently assisted by ABL. For the same reasons that have made it so popular for other financings, ABL is actually utilized pretty frequently to assist with financing acquisitions. Even though buyers of businesses typically operate in multiples of EBITDA, astute investors understand the importance of a well-designed ABL.
As an illustration For ten times EBITDA, a fictitious equity sponsor purchases a business. They give equity to cover the remaining loan financing, which amounts to six to 6.5 times EBITDA. Four to five times senior debt and the remaining amount in expensive junior debt might make up the 6.5x debt financing.
However, ABL might not even be a multiple of EBITDA. Since you’re not basing it on the EBITDA, you might actually be able to supply more, if not all, of the capital in the form of low-cost senior loan.
Myth: The cost of ABL is relatively high
Due to high historical recoveries, modern ABLs are actually affordable, despite their potential high cost during the “loan of last resort” era. According to Downs, “if the bank is just margining assets for the ABL, they know that the bank will be able to get their money back by selling the assets if the company ever does have trouble.”
According to ABL, a company that receives a $300 million loan from a bank is likely to have $400 million in assets. Even if their profits plummeted, they would still own $400 million worth of assets. Therefore, if needed, the bank can still sell those assets to recoup its investment.
In that case, there would be almost little loss given default, or predicted loss in the event that the loan defaulted. Plus, they can price it lower than a regular cash flow loan because the loan has such a minimal loss given default.
Myth: ABL needs a lot of upkeep or detailed reporting
Because today’s borrowers report electronically, the amount of reporting required isn’t nearly as substantial as it was “in the old days,” despite the fact that it still exists. On the first day, you can configure reports to run automatically at the end of each reporting period. More significantly, maintaining the stringent covenants imposed on cash flow loans frequently requires much less work than reporting the quantity and value of collateral.
When taking out an ABL loan, mainly, just keep your liquidity up to date. In fact, this facilitates borrowing in both the High Yield market (usually unsecured) and the institutional syndicated Term Loan B (secured).
We don’t have traditional covenants, so those creditors are aware that we won’t automatically place them in default in the event of a business downturn. Before the ABL truly defaults, the borrower and junior lenders have the opportunity to assist in addressing the earnings or liquidity shortage.
Bottom Line
Asset-Based Lending (ABL) is an innovative, cost-effective financing solution that is often misunderstood due to long-standing myths. Contrary to misconceptions, ABL is not just a last-resort loan; it is a versatile capital markets instrument, particularly suited for companies with strong assets but lower cash flow. In Pakistan, JS Bank offers flexible asset-based loans designed to help businesses optimize their working capital and navigate cash flow challenges.
