When (and Why) to Consider Asset Based Lending

By: Jeffry S. Pfeffer :: August 12, 2016

Today, more than ever, small to medium sized businesses face limited financing options for common growth challenges: the need to finance accounts receivable and inventory, improve cash flow, and fund equipment purchases. For these growing businesses, obtaining credit through conventional lending sources such as commercial banks can be yet another challenge.

One alternative that is active in growing and retracting economies alike is asset based lending (ABL). ABL is well known throughout the middle market business community, with both bank and non-bank lenders providing business financing using asset based lending due to its effectiveness and governing parameters.

Unlock the leverage that can help grow your business

Asset based lending allows a business to be funded by using its assets as collateral. A company can support its working capital by agreeing to pledge its accounts receivable (usually creating 80% to 85% of credit availability) and inventory (up to 50% typically advanced on raw material and finished goods).  A properly advanced and monitored ABL revolving line of credit can help a company grow beyond its balance of accounts receivable, inventory and accounts payable.  Annual capital expenditures can be funded on an equipment line of credit and periodically turned out to term loan or equipment leases depending on the company’s needs.

Asset based lending is a good match with small to mid-sized growing companies that are profitable but may not have healthy contribution margins, known as earnings before interest, taxes, depreciation and amortization (EBITDA), that allows a company to attract unsecured credit lines or general collateralize loans.  ABL loans are ideal for businesses that have tangible assets such as account receivable, inventory, and equipment to pledge and measure for the lenders to feel adequately protected as they lend. Companies that have a strong earnings profile and are asset-light relative to working capital will likely have more availability from a cash flow loan product; however, companies that are more asset-intensive will benefit from an asset-based structure.

Asset based loans are a good fit for manufacturers with leveraged balance sheets and/or tight contribution margins. Traditionally used for working capital purposes, ABL’s can also be very effective in restructures, dividend recapitalizations and buyouts.

One of the most effective features of an asset based loan is that it can create liquidity from a company’s inventory. Traditional banks favor accounts receivable financing as it is an asset closest to cash in terms of being liquid.  Equipment and real estate are longer term assets and depending on their attributes, various financing options exist for both. Inventory requires a lending source that both understands its value as collateral and, if needed, how much that lender can obtain for the inventory in liquidation. ABL organizations monitor their collateral bases closely and keep tight control over how much of a loan is outstanding compared to the assets being levered.

Although asset based financing has a number of advantages, it does have some limitations. The most obvious and important limitation is that your company must have tangible assets that lenders value as collateral. When an ABL lender performs due diligence on the assets, they are looking at the credit quality of the accounts receivables, sales concentration, aging of the accounts receivables as well as other factors to determine what their advance rate will be. For inventory, raw material such as commodity input could achieve a higher advance rate versus packaging inventory or a finished good.  Finally, work in process (known as “WIP") usually never gets advanced on as an ABL is looking at the collateral at a point in time, and what they can realize if they need to sell the assets to recover their loan. 

Know your lender before you commit

Businesses need to make sure they understand and get to know their lending partner because that relationship can be critical to long-term success. Find out how long they’ve been in business. Do they specialize in ABL or is it a small part of the organization? Ask how they are funded – you don’t want their problem to be your problem. Does your company fall into the range of the lender’s average sales size and industry targets?  You may not want to be the lender’s largest loan– or the smallest.

At CapX Partners, we approach every company as unique and seek to tailor a capital solution that fits its needs. What might have worked with another company simply might not be the right approach for yours. CapX looks to first understand your strategic direction and organizational goals. We then quickly and efficiently conduct a comprehensive review of your opportunity and advise how we can help. Our goal is to address your funding needs of today with an emphasis on setting your company up for long-term success.


Jeffry S. Pfeffer, Managing Partner

In 1999, Jeff co-founded CapX and is the firm’s Managing Partner. His responsibilities include firm management, leading new business development, and serving as CFO for CapX.

Jeff has over three decades of small to midsize business finance experience focusing on delivering superior risk-adjusted returns to CapX’s investors. He co-founded the firm during an investment vintage when alternative secured financing strategies were deemed not “sexy.” He and his partners raised over $450...