Categories of Banks
Working Capital from Real Estate
Asset Based Lending Versus Commercial Bank Cash Flow Lending
Let’s face it; there has been significant liquidity in the marketplace over the past couple of years. Debt and equity capital has been relatively easy to find and commercial banks have been very willing participants as capital providers. However, many of the commercial banks have admitted that this robust marketplace is a prolonged cycle and not a permanent or semi-permanent marketplace shift. By definition as a cycle, what goes up must come down.
Already, many of the commercial banks are starting to whisper about declining portfolio quality and tighter credit standards. This has been attributed to issues regarding the sub prime mortgage market, rising energy costs, and other economic factors. These issues have resulted in some companies experiencing a weaker balance sheet
and a decline in cash flow results.
As banks start to tighten their credit standards, many companies may find they have less access or no access to working capital from commercial banks. Banks may elect not to renew certain loans
that come due. Also, companies that have tripped a covenant or are in a technical default may find that their commercial bank is not as patient and has asked that the loan be refinanced.
So how can a company still access adequate working capital in a changing bank marketplace? One way is to mine the balance sheet assets through an asset based, working capital line of credit
. Asset based lending
is more common than ever and has become for many companies a more aggressive way to grow their business. Asset based lenders
look beyond a company’s cash flow and balance sheet ratios to leverage the business assets for working capital purposes. Asset based lenders
also provide an ease of doing business and typically have less restrictive operating covenants than commercial banks.
Commercial banks typically underwrite and grant credit by emphasizing in the following order:
1) Balance sheet strength/Cash flow
Asset based lenders
assume there is some fundamental weakness to #1 above (at least by commercial bank standards) and flips the above equation upside down. The result is asset based lenders
typically underwrite or grant credit by emphasizing in the following order:
3) Balance sheet strength/Cash flow
By emphasizing the value of a company’s assets as security and collateral for a working capital line of credit, an asset based lender
has greater patience and tolerance for the bumps in the road and inconsistencies in the marketplace that many companies will face on a regular basis. Asset based lenders
typically will provide a revolving line of credit against accounts receivables and inventory as collateral. Many asset based lenders
will also provide term loans against equipment and possibly real estate.
Obviously, asset based lending
is not the answer for every company’s need for working capital since not all companies generate these types of assets. Companies selling at retail or on cash terms don’t typically generate commercial accounts receivable which is the asset that most asset based lenders
leverage as the base for a loan. However, if a company is involved in manufacturing, distribution and many of the service industries, chances are they would generate the types of assets favored by asset based lenders
The benefit of this type of lending is that the loan availability can grow as a company’s assets grow and, therefore, is not as restrictive as traditional commercial bank cash flow lending; especially in rapid growth situations. Since asset based lenders
rely primarily on the company’s collateral versus its cash flow results, they are able to embrace greater credit risk and accept inconsistent cash flow results versus commercial banks.
So as the marketplace changes and as commercial banks start to tighten up, remember that accessing adequate working capital may be as simple as mining the balance sheet through asset based lending