Asset-based lending is a revolving credit facility sized against the assets on your balance sheet, mainly receivables and inventory, rather than against a multiple of earnings. The lender works out what your collateral would be worth if it had to collect or sell it, and lends a portion of that figure. A cash-flow lender, by contrast, starts from how much debt your EBITDA can carry. The amount you can borrow moves up and down with your working capital, which is why ABL tends to suit manufacturers, distributors, wholesalers and other businesses that carry real receivables and stock.
The mechanics are simple enough on paper, but several of them catch first-time borrowers off guard.
How an ABL revolver works
The borrowing base
Everything in an ABL facility runs off the borrowing base. It is a calculation, usually submitted on a form called a borrowing base certificate, that takes your eligible collateral, applies an advance rate to each category, and subtracts any reserves the lender has set. The result is the maximum you can have drawn at that moment.
Advance rates vary by lender and by the quality of the collateral. On eligible receivables they are commonly in the region of 80 to 85 percent. Inventory gets a lower rate because it is harder to turn into cash, and lenders often set it as a percentage of the inventory's appraised net orderly liquidation value, or as a lower percentage of cost, whichever produces the smaller number. Work in process is frequently excluded altogether.
Eligibility
Not every invoice or pallet counts. The credit agreement lists what is ineligible, and the list is long. Typical exclusions on the receivables side include invoices aged beyond a set number of days, amounts owed by affiliates, receivables from customers who are also suppliers (the lender will net off what you owe them), foreign receivables without credit insurance, and the portion of any single customer's balance above a concentration limit. Many agreements also have a cross-aging rule: if enough of one customer's balance is past due, the whole balance can drop out.
On inventory, lenders commonly exclude slow-moving or obsolete stock, consigned goods, goods in transit, and stock held at third-party sites unless the landlord or warehouse operator has signed an access agreement.
Availability
Availability is the borrowing base minus what you have already drawn, and it is the number that matters day to day. A hypothetical example helps. Say a distributor has $10 million of receivables on its aging. After ineligibles, $8 million qualifies, and at an 85 percent advance rate that supports $6.8 million. Add an inventory component of $3 million and deduct a $500,000 reserve, and the borrowing base comes to $9.3 million. If the facility is a $15 million revolver, the company can still borrow only $9.3 million. The headline commitment is a cap. It is rarely the amount you can actually reach.
Field exams, appraisals and ongoing reporting
Before closing, and periodically afterward, the lender sends examiners to test the collateral. A field exam looks at your receivables and inventory records, ties the aging to the general ledger, tests a sample of invoices against shipping documents and cash receipts, reviews credit notes and dilution, and checks that the numbers on your borrowing base certificates were right. Inventory appraisals are usually done by a separate firm that estimates what the stock would fetch in an orderly liquidation.
Once the facility is live, expect a borrowing base certificate monthly, and in some structures weekly, along with receivables and payables agings, inventory reports and financial statements. Exams and appraisals recur, often once or twice a year, and more often if availability runs thin or results disappoint.
Springing covenants and cash dominion
A common attraction of ABL is lighter financial covenants. Many facilities carry a single fixed charge coverage ratio that only applies when availability falls below a threshold set in the agreement. Above that line, the covenant sits dormant. Below it, the covenant is tested, and a business that has drawn down hard because trading is weak may find itself tested at exactly the wrong time. Model how close your seasonal low points come to that trigger before you sign.
Cash dominion is the lender's control over your collections. Customer payments go into an account the lender controls and are applied against the revolver, and you redraw what you need. Some facilities run full cash dominion from day one. Others have springing dominion, which kicks in only when availability drops below a set level or a default occurs. Either way, your treasury team will need to adjust how it handles receipts.
When ABL beats a cash-flow loan
ABL tends to make sense when a business has substantial receivables or inventory and its earnings are thin or uneven. A cash-flow lender sizing off a weak year of EBITDA may offer very little. An ABL lender looking at the same company's collateral may offer considerably more, with fewer maintenance covenants.
It also fits seasonal businesses that build stock ahead of a peak, companies growing fast enough that working capital consumes their cash, and businesses going through a turnaround or a refinancing where the lender group has lost patience. Pricing on ABL can be competitive with cash-flow debt for the same borrower because the lender is relying on collateral it monitors closely.
It is a poor fit for service and software businesses with few hard assets, and for companies that would struggle with the reporting. If your receivables are small relative to the debt you need, a cash-flow or unitranche structure is usually the better place to look.
Costs that tend to be underestimated
The interest margin is the number everyone compares. The other costs get less attention:
- Unused line fees on the undrawn part of the commitment.
- Field exam and appraisal fees, which the borrower pays, along with examiners' expenses.
- Collateral monitoring or servicing fees on some facilities.
- Legal costs for both sides at closing, plus landlord and bailee agreements.
- Early termination fees if you refinance within the first year or two.
The bigger cost is often internal. Someone in finance will spend real time each month on the borrowing base certificate and the exam requests. Reserves can also appear during the life of the facility at the lender's discretion, typically framed as its reasonable credit judgment, and a new reserve reduces availability immediately. Building a cushion into your liquidity planning is sensible.
How to prepare for a lender's field exam
The first exam shapes the relationship, and the findings feed straight into your advance rates, ineligibles and reserves. Preparation pays off.
- Reconcile the receivables and payables agings to the general ledger at month end, and be ready to explain any difference.
- Clean up old credits, unapplied cash and disputed invoices before the examiners find them.
- Pull a sample of invoices with proof of delivery and cash receipts so testing goes quickly.
- Document how you issue credit notes, rebates and returns, since dilution drives reserves.
- Get a current perpetual inventory report, last physical count results, and a list of any stock held off site.
- Identify customer concentrations and any customers who are also suppliers.
- Have one person own the process and answer questions the same day.
Examiners tend to be more comfortable with a business whose records tie out and whose finance team knows its own numbers. That comfort shows up in the terms.
If you are weighing an ABL facility against other options, Kenward Partners can help you work out whether the structure suits your balance sheet, prepare the collateral information lenders will ask for, and run a process across banks and specialty ABL lenders so you can compare terms side by side.
