Business Credit Line Needs ? ABL Is The Bank Alternative
Business Credit Lines Shouldn’t Be An Ancient Art
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The business credit line in Canada. New clients we meet can visualize it... they sometimes can't access it - it's almost as if it’s an ancient art they haven’t quite perfected. As a result... cash flow and working capital challenges. Does it have to be that way? We think you know the answer already... it doesn't, and here's why. Let's examine the ABL bank alternative.
Clients at 7 Park Avenue Financial find asset-based lending is the perfect credit line when traditional financing is not a good alternative or an alternative at all! This type of business credit line has some cost benefits, as well as having a large amount of flexibility. Additionally, you self-manage the facility to a large degree with no intrusion required into your suppliers or clients. Many companies have a measure of seasonality to the business, so ABL, ' asset-based lending ' addresses that very well as limits are quite flexible and can be adjusted to your needs.
Why Use An Asset-Based Lending Company?
Alternative funding via ABL asset-based loans is clearly becoming the bank alternative and is widely used in the United States, where this type of business financing originated. Focusing on the liquidity of key current and fixed assets, these credit facilities have become the business finance alternative for borrowing for operating facilities. Some business owners will be surprised to know that ABL lenders can also be banks. These units operate as smaller boutique financing lenders within the traditional banking system, both in the U.S. and certainly in Canada.
We can make the business case that ABL Lenders are more comfortable in lending to many firms when banks either won't or cannot simply because they are experts in collateral value and have the ability to adjust the line against the credit lines they have set. One expert has called it ' real-time ' lending!
Business credit lines via ABL finance lending are attractive to Canadian businesses seeking financing for various reasons in almost any economic time, pandemics included. In fact, asset-based lenders, for the most part, continue to fund business which has significant value to firms looking to access cash flow or to achieve more financing than they could otherwise achieve through traditional sources. Even companies that are restructuring can source business credit line arrangements based on assets.
Benefits of ABL Finance
The ability to have a source of credit that is creative and flexible will almost always provide greater liquidity to your company, with less reliance on the banking covenant-based lending championed by Canadian banks. That's the business lending that 7 Park Avenue Financial clients tell us they want. The trade-off to the typically higher cost of an ABL line is increased access to capital, notwithstanding your obligation to be in a position to report more regularly on asset values such as a/r and inventory, which most firms should be looking at anyway, right?
For this type of business credit line to be successful, your company has to have the ability to create the usual management reports that highlight your asset accounts so that typically would be aged receivables, payables, and inventory lists. That allows you to successfully manage and access this creative way of financing your business. Part of the challenge of those business credit lines is simply the fact that the majority of business owners and financial managers are fairly focused only on one solution - which is, of course, the commercial bank line of credit.
That is definitely one solution. The other (What? There's Another?!) is a non-bank asset-based credit line facility. Both facilities monetize your receivables and inventory... the difference then? ... The Asset-based credit line often monetizes and equipment and real estate also; as part of your overall borrowing power. The big difference is the real key point here - lending is more generous in a non-bank asset credit line.
Receivables and inventory are margined more aggressively, and in bank scenarios, rarely are your unencumbered fixed assets monetized into credit lines.
Why Should Your Company Consider An Asset-Based Lending Business Credit Line?
Most small and medium-sized companies in Canada recognize that Canadian banks cannot meet all their borrowing needs. This might be for a variety of reasons which include profitability, an industry being ' out of favour, 'or the actual financial results of a company that might not have the balance sheets and income statements they require to lend against, given the banks are both regulated and somewhat risk-averse relative their fiduciary responsibility to shareholders and depositors.
It is a true irony of Canadian business that banks generally do not like a firm growing, for example, at 25% per year, which then requires constant working capital needs. Because non-bank business credit lines have your borrowing against sales and assets, there is no concern of higher growth, which is, in fact, encouraged! More cash availability than standard bank offerings is the cornerstone of borrowing against your sales and core assets.
It's not about the financials; it's about sales/assets. As we have noted, the thousands of companies using asset-based credit lines in Canada use it for different purposes. Some companies might be early-stage, some might be in high growth mode, while other companies that are, in fact, bank worthy utilize it because rates in high-quality companies can be very competitive to low bank rates. Naturally, the current low rate environment for business borrowing in Canada is a plus for all borrowers.
Some firms experienced a level of distress might be using the facility based on the amount of their assets that still qualify for borrowing under a credit facility. These companies might find themselves in the ' Special Loan ' category of the bank. This can be a stressful transitionary period on the road to business financial recovery - asset-based financing works very well to correct the financing. It allows a company to get back on track.
At this point, customers would already be reporting on their financial more often and assessing a workout plan that might get them back into traditional banking, or on the other hand, transition their senior lending facilities into asset-based business credit lines. They might still well be 100% financeable with having to raise additional equity or outside collateral. It allows troubled firms to protect the company with a workout refinancing that makes sense, often paying out the bank in the process.
The options and financing flexibility alternative your firm now has allows you to operate daily successfully. As your revenues grow, your receivables and inventory will always fluctuate relative to business growth and how you manage your current assets. Those daily changes drive the ABL credit line. Many firms in high growth / hyper-growth find they cannot satisfy traditional bank requirements. The asset-based facility focuses on your sales and assets, not financial statement ratios within your balance sheet or income statement.
How Asset-Based Lending Works
Allowing your financing partner to assess asset values and growth potential properly allows you to borrow effectively on your sales and assets' true market value. For example, receivables are typically financed at 90%, and inventories are margined based on the type of inventory your firm has. It should be noted that many industries are different when it comes to quality and type of assets; your facility will resemble the industry norms around types of assets. Both banks and asset-based lending firms recognize specific aspects of your industry.
The two main sources of borrowing in this type of credit line are your receivables and inventory. They are the main drivers that determine your facility's amount, but there can easily be a fixed asset/equipment component to the borrowing for all the hard assets your firm owns. The true strength of this type of revolving credit is that it can grow as your sales revenues and other assets grow - they, in fact, determine the amount of the credit line.
There are some straightforward formulas around how these assets are margined for lending. As your sales grow and you collect your receivables, the ABL business credit line fluctuates, allowing you to borrow less .. and finance less, or, more importantly, borrow more if you need it! We have referenced those other assets you can borrow against within your credit facility, with those two asset categories being equipment and, if applicable, real estate. Those amounts have a value assigned to them at the start of your facility working, which might include an outside appraisal to determine maximum borrowing power.
Naturally, these two categories of assets are typically not in Canadian chartered bank business credit facilities, so they highlight the benefit and flexibility of revolving ABL facilities. Many companies that cannot satisfy bank covenants, ratios, outside collateral etc., find they can easily double their borrowing power using the high borrowing leverage of a/r, inventory, and equipment/real estate.
That becomes the ABL business credit difference, a business finance solution tailored to your company's specific needs. Your credit line availability is calculated on an ongoing basis, allowing you to plan for your business cash flow needs - at the end of the day is ' quicker borrowing. '
Accounts receivable plays a major role in the asset-based business credit line model. Your financing firm will focus on the type of receivables you have, average size, major account concentrations with any one customer, account contras with suppliers that might be in place, as well as your a/r days sales outstanding turnover and bad debt.
Businesses should also be prepared to demonstrate that CRA and provincial HST is not in default. Still, borrowers in default will be happy to know that these debts are often paid out of the first advance in ABL business credit lines by asset-based lenders.
The use of your business credit line in Canada, whether it's a bank line or non-bank in nature, can be viewed as a ' replenishment ' of cash from funds your firm has invested in working capital and fixed asset accounts. That need becomes even more acute when your business is growing. The simple reason - you've got more sales tied up in still uncollected receivables, inventory, and the need for some fixed asset or technology replacement here and there! Whether you disagree or not, all banks have particular rules in Canada around business credit lines.
Bank credit lines for start-ups or very new businesses in Canada essentially... don't exist! That’s because of our strong banking system in Canada places a large emphasis on strong historical financial history, solid profits, and squeaky clean balance sheets. So while corporate credit risk at banks for the middle market companies in Canada at banks focuses on profit, cash flow generation, and shareholder equity, ABL focuses on asset turnover and turning business assets into cash. We can say that the shorter-term operating cycle of a business is what drives asset-based loans.
Business owners, if not familiar with The Cash Conversion Cycle, would benefit from checking it out. It is really tied into the concept of cash flowing your working capital assets and how turnover affects the liquidity and the need for more outside business credit. A credit line's continual revolving ability works without your firm being tied to any installment and loan debt. Here the power of ABL kicks in because as sales revenues grow, cash flow via the abl line increases and receivables and inventory is liquidated.
If your firm is offside on banking requirements, it's still exceptionally very safe to say that you qualify for an asset-based credit line from a non-bank commercial finance firm. And that higher leverage and borrowing power is still there, of course - it’s another major appeal of the ABL (Asset-based Line). By the way, if you are, in fact, 'off side' with your bank on their key metrics, ratios, covenants, and collateral issues, the ABL line rides to the rescue more time than you think. So while your business may have temporarily stumbled, the non-bank asset-based line of credit steps in to keep cash flowing and working capital working!
There are different credit types and credit risks, and the asset finance underwriter is well-positioned to take the time to understand your firm's situation. It's not pure roses and sunshine all the time with your business credit line. It would help if you always were prepared to supply proper reporting and updates on your business assets, even more so with ABL-type facilities, which in some cases might even require due diligence visits, appraisals, etc.
There are several supplementary/complementary solutions to the asset-based credit line - These can be used with or separate from your business credit line facilities in asset-based finance. One of these is Purchase Order Financing. This solution becomes extremely valuable if your firm is in a position to receive large orders or contracts that in the normal course of your business you would be unable to finance due to the working capital component of the transaction, namely having to pay suppliers, facilitate your order or service, and then wait for the collection of your receivable related to that order/contract.
The financing works as follows - your supplier is paid directly by your P O financing firm asset-based lender. The receivable attached to that order or contract can then be financed under your already in place asset-based lending facility, or in some cases, a separate P-O Finance arrangement if you do not have either a bank credit line or an asset-based line in place.
Purchase order financing rates are higher, and your firm must have good gross margins to absorb the 2-4% fee on order. Still, it can be invaluable to firms looking to grow larger without access to traditional finance. If there is a bottom line here in corporate finance, the business owner/financial manager needs to understand both the alternative to credit lines and the nuts and bolts of how and why they work best.That will lead to a better capital structure and a more guaranteed level of long-term success.
If you want to consider revolving credit lines based solely on collateral value or new and replacement alternative credit facilities, seek out and speak to a trusted, credible, and experienced Canadian business financing advisor. You want a finance partner/advisor that has a solid knowledge of the ABL lending market and has the capabilities and expertise and a financing track record of facilitating business credit line needs.
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Stan Prokop is the founder of 7 Park Avenue Financial and a recognized expert on Canadian Business Financing. Since 2004 Stan has helped hundreds of small, medium and large organizations achieve the financing they need to survive and grow. He has decades of credit and lending experience working for firms such as Hewlett Packard / Cable & Wireless / Ashland Oil