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Asset-Based Lending, Factoring and Accounts Receivable Financing


Asset-Based Lending, Factoring and Accounts Receivable Financing

Many times, a small business owner needs help with cash flow but is not certain how to improve it.  Some think “line of credit”.  Some go further, looking for an Accounts Receivable Line of Credit.  Some might want to factor their Accounts Receivable.  Some may be after an Asset-Based Line of Credit (ABL).  While all these inquiries are aimed toward the same goal—improving cash flow—many business owners may not grasp that each of these are actually different product options that may be available to them. If you understand the differences between each type of credit facility, then you stand a better chance of finding the cash flow improvement strategy that best fits your company.

Understanding the Products

An Asset-Based Line of Credit (ABL) is a revolving line of credit that allows you to borrow money based on the total value of the assets used to secure the line. Typically, the borrowing base is determined as a percentage of the value of your company’s assets. The assets most often used are current assets such as Accounts Receivable and Inventory; however, fixed assets such as equipment, etc. can be eligible, depending on the lender. The percent of the value you can borrow against also depends on the lender and your business’s creditworthiness, but generally 75-90% of the value of eligible accounts receivable is the bulk of the collateral backing most ABL facilities.  Eligibility of accounts receivable vary lender by lender but the following accounts are just a few of those typically deemed to be ineligible:  invoices over 90 days from invoice date, accounts with excessive concentrations, contra accounts, and intercompany transactions.  In addition to Accounts Receivable, the collateral pool can include Inventory, Machinery and Equipment, and sometimes even Real Estate.  Advance rates vary tremendously for these asset classes; however, the amount eligible will most always also be tied to a percentage of Accounts Receivable.   Once your borrowing base is determined, an Asset-Based Line of Credit gives you the flexibility to draw from the line as you need it.

Factoring helps bridge the cash gap with the value in your outstanding business-to-business receivables. Typically, Factoring is broken down into two types.  With traditional factoring, often called non-recourse factoring, the financier simply buys the invoices and the right to future payments on them from you at a discount.

Recourse factoring, more often called Accounts Receivable Financing, is the more common version these days. This type of factoring is typically more flexible and is less invasive to your business and your customers.  Instead of buying your Accounts Receivable from you, the lender advances a percentage of certain invoices presented for funding.  That way, you can borrow against Accounts Receivable the day you invoice rather than having to wait for your customer to pay.  Typically, the lender charges a service or discount fee for providing the immediate access to the cash.  With Recourse Factoring or Accounts Receivable Financing, you are still responsible for the payments being made in case your customer cannot pay.  Typically Accounts Receivable Financing is a less expensive form of financing than traditional non-recourse Factoring.

With most ABL, Factoring and A/R Financing transactions, payments from your customers are made directly to a secure lockbox with payments automatically being used to reduce the loan balance.  With ABL and A/R Financing, payments are typically made in your name, so your customers need not necessarily know that you’re using alternative financing.  With Factoring, checks from your customer may be made payable to the Factoring Company.

From the Lender’s Perspective

More due diligence is required to underwrite an ABL deal than a Factoring facility, and the risk involved relies more on your business’s credit and less on that of your customers. Because of these factors, Asset-Based Loans are typically available to larger companies with better reporting capabilities and better credit history. The upside is that if your company can supply the necessary reporting required for an ABL credit facility, ABL rates are generally much lower than factoring. Plus, as your borrowing base is determined by availability rather than invoice by invoice, ABL deals involve a simpler ongoing verification process. So while more due diligence is required upfront, much less contact with your customer base is required from your lender throughout the life of your loan.

Factoring is a bit riskier for the lender than Asset-Based Lending, as the lender takes all the credit risk if your customer is unable to pay the invoice. Factoring transactions are often offered to smaller companies with poor or no credit and financial history. Both factoring and A/R credit facilities can be more expensive than ABL lines, but the creditworthiness of your customers can play a larger role in your eligibility. However, factoring and A/R credit facilities often stipulate a higher level of interaction with your customers, with some lenders requiring notification and verification of every invoice.

Accounts Receivable Financing is less risky for the lender than traditional factoring as it considers both the credit worthiness of both your customers and your business.  Usually, with an A/R Finance credit facility, the lender will be able to give you much more flexible terms than a traditional factor. The lender may require more contact with your customers, but the upshot is that many A/R finance companies will take over the responsibilities of A/R management and collections, if you choose, streamlining your business with back office support.

Bottom line: Which is right for your business?

Finding a credit product for your small business often comes down to meeting the lender’s criteria. Finding the right credit product means being aware of the many funding options available and comparing different lenders to find not only the product but also the lender that can fit your needs.

As with every loan or line of credit, it’s always important to consult your trusted advisor (banker, attorney, CPA) so you can determine which product is best for you and your company and best fits your cash flow needs.

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