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Asset-based lending is changing the face of corporate financing in the UK. In less than ten years the amount raised by British businesses using this funding method has increased by a staggering 200 per cent, from £2 billion in 1993 to £6 billion today[1]. While clearly good news for asset-based lenders, this is also great news for the UK economy as it underlines a significant change in the corporate finance market – the advent of genuine choice.

Until recently, businesses seeking finance were limited to bank overdrafts, loans, venture capital or issuing stock. A major drawback of these methods is they all result in a level of control being handed over from the company to the financier.

Asset-based lending differs from these traditional forms of corporate finance because the funds are effectively coming from within the company itself, and thus control of the firm and its future development continues to reside in the hands of the management team, not with an external financier.

As the name suggests, the aim of asset-based lending is to maximise the level of finance available to a business against the current value of its assets. This generally includes trade debtors at the heart of a transaction. However, unlike traditional financial institutions, asset-based lenders also release the value tied up in current assets, such as stock, fixed assets (including plant and machinery), and freehold and long-leasehold property
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In the US, asset-based lending has been successfully used by businesses for many years and is now one of the major forms of corporate finance. According to figures from the Commercial Finance Association, the current outstandings in the US asset-based lending market exceed $200 billion.

While commercial banks are traditionally known for actively seeking out ‘clean’ deals (eg no turnarounds, sound operating histories, healthy balance sheets), the US is seen as a place where success favours the brave, and taking a risk is seen as a valuable source of experience.

For the growing number of entrepre-neurs, who found it difficult or undesirable to fund their businesses through traditional means, a different way of financing was needed and hence asset-based lending was developed.

Detailed valuation of the specific assets to be funded and structured financial reporting gave lenders the confidence to stretch funding over and above the amount that would typically be available under a formula-driven approach. In addition, the experience gained has created a pool of knowledge that can be applied to the valuation of assets when borrowers enter into bankruptcy or file for Chapter 11.

Invoice discounting and factoring companies in the UK have developed some of the skills necessary to support this type of lending, in particular auditing of the sales ledger or receivables. However, few have moved beyond this and, indeed, there is still a great variance in the depth and frequency of the audit itself, with some of the smaller players leaving such a review to the sales team in the quest for speed of response.

The major asset-based lenders differ from smaller lenders as they have dedicated audit teams, and have developed clear audit processes which allow for early identification of significant exceptions. Such audit teams run to clear audit schedules, which can be adjusted if the risk rating of any borrower changes.

The in-house team are also responsible for reviewing, recording and reporting systems for stock/inventory and for testing stock valuations. For those borrowers where the stock may be non-standard, then the asset-based lender will call in the services of a specialist valuer or tap into the knowledge base of its parent company.

Property, plant and machinery will always be valued using the services of an external valuer, and the due diligence review will take into account future market expectations and environmental matters.

In determining their appetite for a particular deal, the asset-based lender will undertake a detailed review of the cashflow and budget projections of its prospective client. Sophisticated modelling techniques are used to ensure the borrower will have sufficient ‘headroom’, in cashflow terms, to be able to weather any deterioration in performance or seasonal fluctuation in sales.

At this stage potential shortfalls can be identified by sensitising sales volumes etc, and in many cases an arrangement can be made to create extra funding availability, either by an over-advance or a temporary increase in the funding percentage.

In its early days, in the UK, asset-based lending was typically centred around MBOs and MBIs. While it is still of considerable advantage to businesses conducting a buyout without diluting equity, asset-based lending is now used with greater versatility in, for example, growth, refinancing or turnaround situations.

This trend in favour of asset-based lending is set to continue, especially as the market approaches an upturn in the economy. Businesses in the UK that are poised to take advantage of these growth opportunities will be looking towards a form of finance that will deliver greater availability of cash to help them exploit this. Asset-based lending delivers just this with its flexible approach.

Asset-based lenders, unlike some other traditional lending sources, take a long-term view on the business providing support through all its growth phases. Unlike venture capital, asset-based lending offers a senior debt injection that minimises the dilution of equity and maximises shareholder value. This enables the management to retain control of the business during a change, such as an acquisition or merger.

The versatility and benefits provided by asset-based lending has led many companies to look more widely at how they source funding on a day-to-day basis and during periods of expansion and M&A.

The result is a boom in the range of corporate finance solutions available to British businesses, and a realisation by many firms that they can use the way they source finance to gain a competitive advantage.Businesses also benefit by gaining a long-term finance agreement, providing a stable base to grow and prosper, and leaving the management teams to focus on what they do best – running and developing the business.

The success of asset-based lending is highlighted by a recent survey with the top UK accountancy firms, conducted by leading independent research agency ICM. This reveals that 82 per cent of professional intermediaries have recommended asset-based financing to their clients, with 86 per cent believing it constitutes an important part of a financial portfolio. One leading player has branded invoice finance as one of the fastest growing working capital facilities for Small and Medium Enterprise businesses (SMEs) in the UK.

As demand for alternative ways to finance a company throughout its life cycle increases, so will the forms of funding available – and British business will benefit hugely as a result.

Further Information
GMAC Commercial Finance plc (the ‘Company’), one of the UK’s leading independent corporate funding specialists, offers bespoke finance solutions across a broad range of industry sectors. It is part of GMAC Financial Services, leading financial organisation. GMAC Commercial Finance has operations in the UK, US, Canada and Hong Kong. The Company has extensive experience providing invoice-financing services.

References
1. Recent figures, produced by the Factors and Discounters Association (FDA), show that asset-based lending has increased from £2 billion per annum in 1993 to over £6 billion per annum today.

(This article was originaly published in Director of Finance 2004 edition)