Working capital financing – why asset-based lines of credit work

How can Canadian business owners and financial managers secure working capital financing and cash flow financing for their business at a time when access to business financing seems to present significant challenges?

The answer is that a potentially solid solution exists under the name of an "asset-based line of credit," which we otherwise refer to as a "working capital facility". What is this type of financing, is it new in Canada, and more importantly – how does it work and what are the benefits and risks?

Although asset-based lenders are typically specialized independent finance firms, many business people are surprised to find that deep in the bowels of some Canadian banks there are small, somewhat boutique divisions that specialize in asset-based lending. Ironically, they often compete with their peers in the more traditional commercial corporate banking business.

The most active assets these companies finance are typically current receivables and inventory, but in many cases, with the help of a professional advisor or partner, you can structure an asset that also includes a component of equipment and real estate.

In general, an asset-based line of credit is a good way to think of a line of credit that allows you to earn higher margins and receive higher advances on receivables and inventory for a temporary period of time, usually about a year in our experience. This means more cash flow and working capital.

One of the main attractions of an asset-based lending facility (insiders call it an ABL facility) is that your company's overall credit quality is not the biggest factor in determining whether you can be approved for this type of financing. As the name implies, the financing goes to your "assets"! And doesn't really focus on debt-to-equity ratios, cash flow coverage, covenants, and external collateral. Business owners who borrow from Canadian chartered banks on an operating or term basis are naturally very familiar with these terms – in some ways, we might call them "restrictions".

Most lawyers and accountants will tell you that any type of business loan should only be entered into with a respected, trusted and credible business finance advisor who can guide you through the obstacles and pitfalls of any commercial financing arrangement. Missteps in corporate financing can lead to long term negative impacts, z. B. If you are tied to a facility, give up too much collateral, or are tied to pricing that doesn't match your total assets and credit quality.

What are the key points to consider when considering such a financing facility? First and foremost are:

-Advance rates for each asset category (A/R, inventory/equipment)

– How is pricing defined (asset-based lines of credit and ABL loans are generally more generous in the overall size of the facility, but you should make sure you only pay for what you use

– Contractual obligation – in a perfect world (we know it isn't!) you should focus on being able to cash out at any time, or at least with some sort of nominal break fee

– Make sure the asset-based credit facility, which generally costs more, allows you to maintain or focus on profitability; we spend a lot of time with clients about how they can defer the additional costs of abl facilities through various strategies

So, what's the bottom line. As always, it's simple: consider asset-based lending and an ABL facility as a solid alternative to financing your business. Work with a trusted advisor, as this type of financing is generally either not understood or not too well known in Canada. Be selective in structuring your investment around issues best suited to your business for derived benefits. This is a solid business financing sense.