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Asset-based lending (ABL) is a type of lending where funds are extended based on the value of a company’s most liquid assets, such as accounts receivable and inventory. The amount advanced cannot exceed the so-called “borrowing base” which is the value of the eligible assets minus a discount determined by the lender. The base is recalculated periodically to ensure compliance and determine how much can be drawn.
ABL financing can come in the form of a loan or a revolving credit facility, also known as a revolver. A loan allows the business to only borrow once while amounts available under a revolver can be reused after they are paid down. Borrowing can be a good option for established businesses that don’t need funds immediately and can meet the requirements set by the lender.
The advance rate varies by the type of asset and tends to be higher on accounts receivable (A/R) and lower on inventory. For more information, please see our Accounts Receivable Factoring page:
A solution that is frequently confused with ABL is factoring. Factoring – also known as invoice or accounts receivable factoring – involves selling invoices at a small discount to a factoring company (factor) that specializes in this type of transaction. Factoring is not lending and is therefore easier and faster to obtain.
Reasons businesses may consider accounts receivable (A/R) factoring include needing to take on a large project that requires upfront payments, working with a large organization that commands longer net terms or funding a rapid expansion.
There are also hybrid arrangements that on the surface look like a credit line but are in fact recourse factoring lines in which the company maintains ownership of the assets and is responsible for replacing receivables that remain unpaid after a certain period of time with ones from creditworthy clients. This type of arrangement can be referred to as asset based factoring.
For an example of this type of arrangement, please see our Accounts Receivable Factoring page.
- Ownership of the receivables. The principal difference between ABL and factoring lies in the ownership of the receivables. Unlike lenders, factors can take permanent or temporary ownership of the receivables making them responsible for their collection. They can also provide additional services, such as invoice processing and credit checks on client’s customers which can save businesses time and money.
- How the underwriting decision is made. Factoring relies on the creditworthiness of your client, not your own. This makes it an ideal tool for newer companies that work with larger, more established clients and might not have access to traditional bank financing. By comparison, asset-based lending underwriting decisions are made based on the payment history of both your business and your clients and the quality of your other assets, such as inventory and, in some cases, equipment.
- Length of the commitment. Loans or revolvers are usually issued for several years. By comparison, factoring does not require a long-term commitment and can be relied upon to convert invoices into cash in 24 to 48 hours. Factoring one or two invoices is called spot factoring, while signing an agreement to sell all of the invoices is known as whole ledger factoring.
- Flexibility. Factors can offer more flexibility to their clients due to not being bound by restrictions inherent to banking. As such, factoring requires far less paperwork than taking out a loan and does not come with restrictions related to the use of funds, profitability, acquisitions, etc.
Asset-based lenders typically require that a company be in business for at least 6 months, have a credit score of 550 or above and at least $1 million of eligible assets. Loans are underwritten based on the lender’s financial analysis of the borrower and its clients and comes with periodic financial reporting and credit review requirements. It may be tricky to secure an asset-based loan for a small or medium-sized enterprise (SMEs) because the cost to monitor a loan from the lender’s perspective is similar regardless of its size.
By comparison, invoices of much less than $1 million can be factored. Business Factors, for example, will factor invoices below $10,000 and up to $12 million. Startups can access factoring services as long as they have creditworthy B2B clients. B2C businesses are generally not good candidates because of the higher risk profile of their customers.
The following documents are usually required to monetize invoices via factoring:
- The completed application. A typical application will ask you to share company information, your industry and the dollar amount of the invoices you wish to factor. A factor may also want to see a sample invoice to ensure that there is nothing wrong with its layout, design and readability. You can get started with Business Factors by filling out a four-minute application.
- Articles of organization or incorporation. These are needed to verify your company.
- Accounts receivable aging report. This is a critically important document that details your pending invoices. It enables the factoring company to verify and identify your clients, check the amounts owed and assess clients’ creditworthiness. Invoices older than 90 days might be ineligible for factoring.
A common misconception associated with factoring is that it is necessarily more expensive than taking out a loan. The price of factoring really depends on the arrangement a business has with a factoring company.
While fees vary by financial institution, general fee structures for both ABL and factoring are outlined below.
ABL lenders usually charge:
- Commitment fee upon extending the loan. Part of that fee goes towards closing fee which is deducted from the proceeds of the facility. Each of these fees ranges from 0.5% to 1% of the total facility.
- Other fees may include an unused line fee, which compensates the lender for keeping the liquidity available to fund the unused portion of the facility, an administrative fee to cover the costs of monitoring and collateral audits and a prepayment fee if the borrower decides to repay the facility before the maturity date.
- The interest rate on the facility depends both on the creditworthiness of your business and that of your clients since they are the ones paying your invoices. In a typical ABL arrangement, you can expect to pay between 7% and 17%.
An example follows:
|1||Eligible accounts receivable||$80,000||$90,000||$70,000|
|2||Loan availability on accounts receivable (Eligible A/R by 85%)||$60,800||$70,650||$50,950|
|4||Raw materials (100% eligibility)||$20,000||$30,000||$40,000|
|6||Finished goods (100% eligibility)||$10,000||$10,500||$20,000|
|7||Total eligible inventory||$30,000||$40,500||$60,000|
|8||Inventory advance rate (multiply line 7 by 50%)||$10,500||$20,250||$30,000|
|9||Inventory cap (maximum amount against which the client can borrow)||$50,000||$50,000||$50,000|
|10||Loan availability on inventory (the lesser of line 8 and 9)||$10,500||$20,250||$30,000|
|11||Borrowing base for this report (sum of line 2 and 10)||$80,300||$90,900||$80,950|
In the example above, the lender has agreed to extend a revolving credit line of up to $10,000. The amount a business can borrow every month is determined by the borrowing base calculation that takes into account a large portion of client’s A/R and half of its eligible inventory. To use the line, the lender charges a business 10% interest per year, in addition to commitment and closing fees of 1% each. The term of the facility is 5 years.
The business would pay $200 for commitment and closing fees. The amount of interest will fluctuate depending on the amount outstanding but could go up to $1,000 if all $10,000 is drawn. The business would pay interest for as long as the facility is outstanding and used.
Factoring fees depend on the profile of the business’s client, the industry, dollar amount of the invoices factored and their number, among other things. For example, fees in an industry where invoices are more likely to get disputed, such as retail, could be higher than costs associated with factoring receivables from a state or government entity.
The general factoring fee structure is described below.
- Advance rate. Advance rate is the portion of invoice paid by the factor and can vary from 70% to 96%.
- Reserve. Reserve, also known as holdback, is the remaining 4% to 30% that the factor can choose to hold until the invoice is paid. Reserve is more likely to be used whenever a physical product is concerned or when the debtor (party that is to pay the receivable) is located in another country, for example. For more information about reserve, please see our Small Business Factoring page.
- Discount rate. This is what a factor charges to monetize your invoice. A typical rate ranges from 1% to 5%.
- Other fees. Other fees charged by a factor can vary from one company to another but may include due diligence, monthly minimums or lockbox fees.
Let’s look at an example:
- Invoice amount: $10,000
- Advance rate: 90%
- Reserve: $1,000
- Fees: Monthly fee of 2%, capped at the amount of the reserve
- Other fees: $100 lockbox fee, capped at the amount of the reserve.
- Type of arrangement: non-recourse
In this scenario, the client pays $300 ($100 for the use of lockbox plus the discount rate of 2%) for the factoring service until the factor collects on the invoice. If a factor is unable to do so, there is no additional charge to the client. The fee comes out of the reserve. If the invoice is still outstanding after 2.5 months, there are no additional fees to the client.
In summary, there are several ways to get working capital leveraging accounts receivables. One is asset-based lending, or ABL. In this arrangement, a business would pledge its receivables and inventory in exchange for a credit line or a loan. Lenders, in turn, would evaluate the assets, the credit profile of both the borrower and its clients and advance only up to a certain amount against these assets to protect themselves from risk associated with “bad” clients or obsolete inventory. The maximum amount a business can borrow against is called borrowing base. To qualify for a loan, a company needs to be in business for at least 6 months, have a credit score of 550 or above and at least $1 million of eligible assets. By comparison, factoring involves selling the receivables to a factor, a company specializing in this type of transactions. Factoring can be done on a short-term or a permanent basis and relies on the creditworthiness of a business’s clients, not their own. It is difficult to compare fees charged by ABL lenders and factors directly, but factoring is not necessarily more expensive. It offers more flexibility and, unlike lending, can be done in a pinch, allowing a business to obtain funds in as little as 24 to 48 hours.