Debt and alternative financing
How does asset-based lending work for growing companies?
Short answer
Asset-based lending is a loan secured by company assets such as receivables, inventory or equipment. The lender sets a borrowing base and advances a percentage of the assets' value. As the assets grow, the available credit can grow with them. Lenders look at the collateral more than at projected profits. Many borrowers talk to an attorney about the terms before moving forward.
How the borrowing base sets your limit
Here is the basic mechanic. A lender typically lends against a percentage of the value of your assets. That percentage is the advance rate. Common collateral includes accounts receivable, inventory and equipment. Lenders often take formal steps to document their claim on the collateral.
Many of these facilities are revolving lines. The borrowing base gets recalculated as your receivables and inventory change, so the credit line moves with the business. Terms vary a great deal from lender to lender, so many borrowers review every document with their attorney.
This suits growing companies because growth eats cash. You ship product, wait to be paid, and buy more inventory. A line tied to assets can follow that cycle. The lender cares more about the quality of the collateral than about the story in your deck.
What lenders want, straight from the lender's chair
This clip shows how one family office ended up lending money, and why it insisted on strong covenants.
I interviewed Alan, who runs a family office investment boutique. His firm likes short duration specialty lending, and he told me plainly that they like hard asset lending. His example was loans against fine art. Here is how he described the protection.
"We store the art in a bonded warehouse, so if the borrower were to default, we have the art in our collateral with the UCC-1 filed against it."
Art is not what a growing company usually pledges. The thinking still carries over. Alan named three things he wants as a lender:
- A hard asset the lender can control
- Short duration with modest advance rates
- A strong attachment point between the lender and the borrower
His number one piece of advice was due diligence. He said you can never do enough. Expect a lender to dig into your receivables, your customers and your reporting. Do the same work on the lender.
Why advance rates stay below 100 percent
A multi-family office executive explains why lending against real estate at a discount to value appealed to their investors.
In that interview, the executive described real estate debt with loan to value ranging between 60 and 80 percent. The worst case, in their words, is that you keep the real estate at a discount. Asset-based lenders think the same way. If they advance less than the full value, they have room to be wrong.
For you as the borrower, that means the line will be smaller than the asset base. It also means the lender will want ongoing reporting. Short duration and modest advance rates are the lender's way of controlling risk, and they affect how much cash you really get.
Where it fits next to other ways of raising money
Asset-based debt is one tool. I often tell operating companies that equity is not the only structure investors will look at. Some operating companies explore income or royalty style structures with their advisors. In my experience, investors often want income with solid collateral behind it.
Be careful about what you pledge. If you default, the lender may have remedies involving the collateral, and the details depend on the loan documents. Do not put up assets your operations depend on without understanding the consequences. If the structure touches investor money, many sponsors talk to a securities attorney about it. Many borrowers also have an attorney look at the loan agreement.
What I have said on this at our events
Collateral matters on the investor side too. I know a group that raises debt notes from investors on a five year term at a 12% return. They use the money to acquire majority equity stakes in companies. As the notes get paid off, they end up owning all the equity. The investors' collateral was the holding company, which already produced tens of millions of EBITDA. That is the point for a borrower. Lenders and note holders both want to see a real asset or cash flowing business behind the promise, so show yours clearly and many sponsors talk to an attorney about how investor notes are structured.
"Another group uses debt notes with investors, with a five-year term, and gets a 12% return. They go and acquire majority equity stakes in companies. As those debt notes get paid off, they're left owning all the equity in the company. The investor got a 12% return on their money, and the collateral was the holding company that already was producing tens of millions of EBITDA."
Facts and figures
- Alan's firm stores pledged art in a bonded warehouse and files a UCC-1 against it, so the collateral is under the lender's control if the borrower defaults.
- A multi-family office executive described real estate debt with loan to value ranging between 60 and 80 percent.
- One family office began lending in 2015 with strong covenants and scaled the lending up in 2017.
Sources
From Richard C. Wilson's Centimillionaire Strategies YouTube channel: Debt, Fine Art, and Collateralize d Investments Investor Mandate Interview, New York City $1B+ Multi-Family Office Investor Mandate Interview on Private Equity, Real Estate,..., From Tech Exec to $100M+ Investor: How He Built His Family Office from Scratch. Quotes come from the video captions, lightly edited for readability. Figures are the speakers' own estimates and experience.
General education only. Not legal, tax or investment advice.
Talk to a securities attorney to explore options around loan agreement terms, collateral and lien matters and investor note structures. Do not use AI to write your own legal agreements.
Your next steps
- 1List your receivables, inventory and equipment and note which are free of other liens.
- 2Ask two or three asset-based lenders how they set advance rates and the borrowing base.
- 3Prepare clean aging reports and financials, because lenders will ask for them.
- 4Compare the debt with income or royalty structures for your raise.
- 5Consider talking to an attorney about the loan agreement and related filings.
Follow-up questions
What assets can a company borrow against?
Lenders commonly look at accounts receivable, inventory and equipment. Some also lend against real estate. Which assets qualify and at what advance rate depends on the lender.
Is asset-based lending the same as a bank term loan?
Not usually. A term loan leans on cash flow and credit history. An asset-based line is sized by the value of your collateral. Many borrowers review the exact terms with an attorney.
What happens if a borrower defaults?
The lender may have remedies involving the pledged collateral, and the details depend on the loan documents. Alan described holding the art with a UCC-1 filed against it for this reason.
Related questions
- What is venture debt and who qualifies for it?Venture debt is a loan made to a venture-backed company, usually alongside or after an equity round.
- How do I raise private credit for my business?Start by deciding which side of private credit you need.
- How does a bridge loan work for a real estate deal?A bridge loan is short-term money that covers a gap in a real estate deal.
- What is mezzanine financing and when should I use it?Many sponsors look at mezzanine financing when senior debt does not cover the whole gap and they want to avoid selling more equity.
Work through it with the waterfall calculator. See all debt and alternative financing resources.