Decades ago, asset-based finance developed a nasty reputation.
As a financing tool that requires business owners to place valuable assets — whether working capital or physical — up for collateral, asset-based financing (ABF) was often viewed as a solution to a dire problem when no other options were available.
"One of the histories of the asset-based loan was that it was a loan of last resort," said Norb Schmidt, executive vice president and director of capital finance at Cadence Business Finance. "From an asset-based perspective, borrowing had a stigma attached to it."
Over the years, the industry has improved that reputation as more sophisticated analytics technologies have allowed for a lower cost of borrowing. For businesses with cash flow lumpiness as a result of seasonality or otherwise, ABF can be a valuable tool to access capital — and doesn't have to be as risky for financiers as some might assume. As Schmidt told PYMNTS in an interview, the ongoing pandemic has increased awareness even further as to the value of ABF to help businesses through volatility, without compromising their banking relationships.
The financial challenges that many organizations have faced as a result of the pandemic can jeopardize their ability to obtain a traditional bank loan or other financing product. One of the greatest advantages of an asset-based loan (ABL), explained Schmidt, is that financiers don't look at income statements as a part of their assessment. Rather, underwriting is based on actual assets on the balance sheet.
"It really helps to offset the impact of a pandemic or any of those kinds of market events," he said.
There has been a slight increase in demand for ABF in recent months, he added, thanks to ABL’s ability to assure capital to businesses when income remains uncertain. For middle-market firms, which comprise the customer base of Cadence Business Finance, assets including accounts receivable and machinery provide solid ground for asset-based financiers, even for businesses in areas like manufacturing that had to adjust their business models in the midst of the pandemic.
"A machining center will still be a machining center, and will still be creating parts, whether those parts are for the automotive sector or for the construction industry sector," noted Schmidt.
The flexibility of manufacturing industries means businesses could shift what they were producing without having to divest valuable assets that could open up doors to capital. Today, Schmidt said that there remains a wait-and-see approach for some organizations in this space that were forced to shutter or slow down operations. Asset-based financiers are taking that same approach, too, although Schmidt said he is confident the ABL arena remains in growth mode.
Blurring the Finance Lines
As that growth continues, more organizations are finding themselves in a position to turn to ABL as a method of first resort.
"Really strong-performing companies that have a measured working capital need like the assurity that comes with an asset-based facility that says, 'My working capital assets are X, and that gets me Y for my borrowing capacity,'" said Schmidt. "It gives businesses that assurity of capital where their first call is not to their banker, but to their sales or operations department."
This could be especially valuable as some analysts predict banks will once again pull back from business lending amid economic uncertainty. That's not to say ABF will overtake bank loans, however.
Rather, Schmidt said he predicts an ongoing harmonization between traditional and asset-based loans.
"The line between commercial bank loans and asset-based loans is blurry," he noted, explaining that some financiers are now blending financing products with an asset-based structure to lower the cost of capital and connect organizations to financing that retains strong balance sheets despite cash flow volatility.
While ABF can still come with negative connotations, the current market climate may offer a platform for the ABL industry to showcase its value to the middle market. And as the ABL arena gets more creative in the assets upon which financing is based, Schmidt said he's seen companies with stronger balance sheets embrace the financing tool not out of desperation, but out of strategic path to capital.