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Strategic Finance

The significance of ABL

Monday, 27 November 2006

Philip Lammas of GMAC Commercial Finance Plc discusses the European growth of asset-based lending. Asset-based lending (ABL) is now an important source of finance for companies looking to restructure and finance their ongoing growth and development. The UK market alone is now estimated to be worth more than £6bn a year.

This may sound like small change compared to the multi-billion pound loan portfolios that many international banks carry, but to write off ABL is a mistake. ABL is worth much more than the sum of its parts because it introduces into European boardrooms a crucial element that has been missing - choice.

And that element of choice, compounded by business growth across Europe and the vast economic potential of the emerging Eastern European economies, is driving a pan-European corporate quest for more flexible funding solutions.

The result is that companies are now actively looking for alternative ways to fund their ongoing business development, make acquisitions and manage cash-flow beyond the traditional sources of finance - the banks and venture capital houses.

While VC and bank finance still accounts for the majority of corporate funding in Europe, the rise of ABL in the middle market, together with other alternative forms of finance, such as invoice financing and factoring, have introduced greater flexibility into corporate funding portfolios. These enable pan-European businesses to structure a finance package that suits the specific needs of their business and environment. It also enables them to match their working capital requirements on a country by country basis, while controlling the businesses group cash flow through one central treasury function. This is achieved by leveraging funding against assets in each jurisdiction.

Crucially for many businesses, ABL often enables them to borrow more money with less risk than they would be able to achieve through traditional financial institutions. Like traditional funders, the asset-based lender will examine debt and outstanding invoices and factor this into the equation when working out how much they can lend. However, the aim of ABL is to maximise the level of finance available to a business against the current value of its assets, such as stock, fixed assets (including plant and machinery) and freehold and long-leasehold property. Additional cash flow lending is also available based on a company's financial performance and future prospects.

While the search for alternative ways to fund expansion and business development in Europe has been responsible for part of the growth in demand for ABL, an equally important driver has been corporate America.

US companies, with the support of their business influencers, including venture capitalists and bankers, have been looking to acquire middle market companies in Europe and their desire to fund these transactions and ensure they are well capitalised with minimum risk has led to an increased use of ABL services.

Recent figures reveal that European middle market deals (ranging from 20m-400m) rose as a proportion of all deals from 16 per cent in 2001 to 25 per cent in 2002, underlining the opportunities that this market provides.

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 $200bn.

While commercial banks are traditionally known for actively seeking out 'clean' deals (e.g. no turnarounds, sound operating histories and 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 entrepreneurs who found it difficult or undesirable to fund their businesses through traditional means, a different way of financing was needed, and hence ABL 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, with obvious advantages for the companies involved.

Europe, and in particular the UK, is often seen as mirroring trends that emerge from the US. The use of ABL in Europe is growing as the economic outlook continues to improve and growth - particularly in the former Eastern Bloc countries - drives demand for finance to underpin booming economies. This growth has been achieved despite the regulatory and legal regimes being different in each country: it should always be borne in mind that the EU is not the United States of Europe.

ABL's ability to provide greater amounts of finance than is often available through traditional funding routes makes it an attractive alternative in Europe's established and emerging markets - particularly in turnaround, refinance and buyout scenarios.

Part of the demand for ABL is being fuelled by market growth in the former Eastern Bloc. In Poland alone, there are now 1.8 million active businesses and its GDP has grown by 225 per cent over the past 12 years.

This growth has been driven not only by national entrepreneurs but also by investment from major global corporations, keen to gain a foothold in these emerging economies and to benefit from the highly skilled workforce and consumption hungry market places that many of these countries provide.

Demand for corporate finance solutions in these markets is being driven by far more than new business start-ups. Acquisitions and restructuring of existing businesses to meet growing consumer demand and the opportunities offered by an expanded EU are generating a booming market and a thirst for flexible corporate finance solutions - and ABL is increasingly being adopted to fulfil this need.

To date the UK is by far the largest market for ABL in Europe. In its early days, ABL was typically used in Britain to finance MBOs and MBIs, where its ability to provide funding against assets without diluting equity or placing additional pressure on the management team to meet the financiers targets, made it a popular alternative.

The success of ABL 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 SMEs in the UK.

The UK, in its position as Europe's most advanced ABL market, is now leading the growth and expansion of ABL financing across Europe. ABL is also growing as a financial medium in much more established European economies, with the partial deregulation of the financial services markets in countries such as Germany and France encouraging companies to look beyond traditional sources of finance and to embrace the flexibility and choice offered by ABL and other alternative forms of corporate finance.

This trend has also seen the emergence of multi-jurisdictional finance packages, developed as a bespoke solution for companies that want to finance their operations across multiple territories but do not want to become embroiled in the traditional network of relationships with a different finance provider in each country.

According to figures from the EVCA, 24 per cent of private equity investments in Europe are now cross-border, involving multiple countries, as compared with 15 years ago, when just seven per cent of European deals involved more than one country.

This form of multi-jurisdictional funding is complex to put together and requires detailed knowledge of the intricacies and workings of all the countries involved but the benefits are great. Having one provider across all operating territories is far simpler and easier to administer and enables the company concerned to develop a close working relationship with a single financier which understands its business and its specific needs.

It also enables the company to work with its financier to release new funds far more easily to enable additional growth and business opportunities to be responded to as they occur. Equally importantly, it provides a very cost-effective way to finance a company's ongoing operations and development, as you pay the fees for one financial adviser rather than 30 or 40.

Providing a continental or even global corporate finance service, coupled with the benefits of detailed local knowledge and expertise is a mantra cited by many businesses as the key to success.

Many of the larger traditional banks and VC companies already provide this type of global service, informed by local knowledge, to large multinationals. But prior to multi-jurisdictional ABL, in the middle market, this simply was not possible. The advent of this service from leading asset-based lenders opens up the market to new forms of corporate finance and provides new opportunities for those companies looking to expand their business across Europe and into new developing markets.

Crucially it also provides new opportunities for many of Europe's existing, established businesses, which have in the past been restricted to banks and VCs for finance.

As the European corporate funding market continues to open up and new forms of funding become available, so more and more European corporations will benefit from the same choice and flexibility that has been enjoyed by companies in the US for decades.

The brave new world of the expanded EU provides great business opportunities for everyone and it seems appropriate that this growth should be being driven by a new, more flexible and more international form of finance - ABL.