Asset based lending leads the way

The past three years have witnessed wide changes in the marketplace and many businesses have, in turn, reassessed the ways in which they fund their ongoing operations. There’s no doubt that the landscape has changed and banks are still making finance available, but it is not a one-size-fits-all approach. Relationship banks are working closer than ever with their core customers to find the right financing solution for each individual situation. Many astute FDs have explored alternative ways to source finance. As a result, there has been a surge in the popularity of a whole range of alternative funding strategies, with FDs and treasurers casting around for solutions to restricted cashflow and more expensive credit. Inevitably that effort will lead many to look at the assets within the business for a solution.  And in a lending environment where the cost of money may be high, sweating assets can strengthen working capital in order to service a major new order or prepare effectively for a seasonal spike in demand; it can offer a competitive advantage by allowing a business to invest in capacity, product development and geographical expansion as well as financing a buyout, merger or acquisition by unlocking the often considerable “hidden” value on a company’s balance sheet.

The mechanics

But what, exactly, does asset finance or asset-based lending involve? Asset-based finance is a means of raising money against assets that you already own or to finance the purchase of new equipment for your business such as vehicles, machinery, raw materials, stock or property. “At its core, asset-based lending will always have an invoice discount and factoring facility, which is releasing cash from trade receivables in advance of debtors paying,” says Martin Cooper, director, Corporate at Lloyds TSB Commercial Finance. As a worked example, Cooper says that for a £50m business with three warehouses etc, the bank would start with an assessment of the management to determine whether they share the same vision and have a plan and forecasts that support that vision. “Then I’d want to ask whether I can meet their needs as established in their plans – what are the main risks and how sensitive are their plans to these threats? I want to put in place a facility that meets their needs and has sufficient headroom that it will cope with any surprises.” 

Typically, the next job would be to assess the company’s debtor book. “This is the asset nearest to cash and will be the cheapest asset to borrow against,” Cooper adds. “I would want to understand the basis of trade and when the debts should get paid, and then review their systems and credit control procedures and the average time taken for debts to get paid. I would assess the quality of customers and would look for a mixed portfolio of customers, with no single debtor representing a significant concentration risk. “We would then assess the stock, looking at its age – anything not currently sold or obsolete would not typically attract any lending value. I would look at the individual stock lines and assess how quickly they turned, and I would assess the risk of faulty or returned or disputed stock and ensure that it was free from any other prior claim from a creditor so that I could attribute a lending value to it and advance money. The cost of borrowing against this asset will be marginally more expensive than debtors.” The bank would then look at the other fixed assets like plant machinery and property, get them professionally valued and then advance money against these assets. The borrowing cost will be more expensive than debtors but will vary on the quantum and term “Ongoing I would reassess the debtor and stock security on a weekly or monthly basis to ensure the money advanced remains secure when compared to the lending value attributed to the assets, adjusting the lending up or down in line with the assets used in the business,” says Cooper.

A question of confidence

Cooper believes the increasing use of alternative finance – and in particular asset-based lending – is a result of several trends. “We saw a peak of refinancing and reassessing options in early 2009 when the price of money had moved considerably and people were sense checking what they were being told by their banks,” he says. “And right now, among both new and existing customers, we’re seeing our strongest take-up of asset-based lending facilities for a while. Companies are recognising that we are in a recovery phase, albeit a slow one, and that now might be the time to look ahead to growth.” Essentially, asset-based lending allows a virtuous circle to develop, as Darren Baker of Lloyds Bank Corporate Markets, which supports business customers with more than £15m turnover, explains. “Previously, businesses might typically have been restricted to borrowing 50 per cent of their debt book for their facilities. By going down the asset route they can increase that and borrow up to 65 per cent of their debt book and also a percentage of their work in progress. We can add value and fund that work in progress. It means we can fund each month their increased requirement because they’re building more and more and they can lean on the bank more and more.” Of course there is a quid pro quo for that increased level of flexibility. “FDs may have to supply us with more data than they might have done previously,” says Baker. “We will lend higher levels and give different lending values to the security, but we will probably expect more transparency and disclosure.”

The flexible friend

Louise Ross, head of Corporate Performance Management at CIMA, says the fundamental advantage that asset finance and invoice factoring in particular offers businesses is flexibility and assurance. “In difficult times, invoice factoring and asset finance does remove an element of uncertainty for businesses – they know what they are going to receive, at least in the short term, for their accounts receivable,” she says. “This form of financing is based on the values of the receivables, unlike loans that are affected by a company’s creditworthiness (a more complex, partially judgemental assessment and one also influenced by changing economic conditions not within the control of the company).” But if using asset-based lending is such an obviously beneficial option, why are fewer businesses using it than we might expect? “Ignorance,” says Kate Sharp of the Asset Based Finance Association (ABFA). “Far and away the biggest problem is lack of awareness. Not enough people know about it, and those that do have preconceptions that aren’t true. The problem is that when it first emerged in the UK it was used in a certain kind of way by a certain kind of company that then gave it a poor reputation, and it’s been stuck with it ever since.” And that flexibility is central to asset finance’s appeal. Martin Cooper certainly thinks so. “Flexibility and speed are the two key benefits that people value, and at Lloyds Bank we can put facilities in place within 24 hours if need be. And then in terms of flexibility, people can use as much or as little as they want. Indeed, once they’ve put in place their line of credit by looking at the assets and establishing what credit that will generate for them, it effectively costs the business nothing until they start drawing the facility.”

A good example of how using asset finance can allow a business to grow in a sustainable fashion comes in the form of the UK’s leading bus operator, Stagecoach. The business has used asset finance for many years, funding its strong growth through all stages of the business cycle. Based in Perth, Stagecoach currently operates around 13,000 buses and trains, and originally approached Lloyds TSB Commercial Finance in 1981 for finance to purchase two new Volvo Duple coaches, which were the flagship vehicles for the Perth to London express service. Since then it has followed a hire purchase model as its fleet has grown. And while large investment in fleet is crucial to the business’s long-term expansion, generating sufficient liquidity to upgrade and maintain its vehicles to the latest standards cannot be ignored. “Clearly the environment and sustainability is a big part of their business and they need to run green,” says Cooper. “So the asset finance model means that not only are they able to replace buses on a regular basis, they can also make sure they are at the cutting edge of green technology.” Clearly Stagecoach has taken the right approach: de-risking its balance sheet by employing a range of financing. Asset-based lending sits comfortably within that, allowing the company to maintain the performance of its fleet without impacting working capital. Given that asset finance is a form of funding directly and tangibly linked to the strength of the business and its underlying value, employing it in such a way makes sense.