Asset Based Line of Credit for Importers

Introduction

One of the greatest challenges faced by importers/wholesalers is managing the cost of higher asset levels related to rising sales. Most importing operations are characterized by the large container load volumes of product. Large import orders require significant funds to pay overseas suppliers. Importers drop/distributors must often warehouse quantities of inventory to deliver on demand to their buyers. Import operations are commonly highly leveraged with irregular or seasonal cashflow. With these challenges Importers/wholesalers are usually hard pressed to obtain reliable, flexible cost effective financing to support their operations.

Importers/wholesalers are now recognizing Asset Based financing as an effective tool to finance imports by leveraging equity in current and fixed assets. Traditional Bank financing is based on a firm's cash flow and net equity. In contrast, Asset Based financing, provided by commercial finance companies, is structured to advance funds based on a percentage of the qualified firm's receivables, inventory and other assets. The value, quality and liquidity of the business assets determine the loan amount for which a business can qualify. Because the loans are secured by assets, finance companies can lend to importer/wholesalers that experience irregular or seasonal cash flow requirements. Traditional Bank financing, which is based on a firm's historical cash flow and net equity, is often not as effective as Asset Based Financing to support an importer's fluctuating financing needs.

Years ago asset-based funding was considered a solution only for companies in financial difficulty. Today asset-based funding is an increasingly common financing strategy for businesses requiring borrowing flexibility to handle fluctuating capital needs. Asset-based borrowing has grown steadily in North America over the 20 years. In 2002, the industry generated over $325 billion in commercial short-term business finance. This represented 26.1 percent of all short-term business debt, up from 20.6 percent in 1997. More than 60,000 U.S. companies make use of asset based loans--31 percent manufacturers, 28 percent wholesalers and 17 percent retailers. More than 71 percent of these businesses are businesses with less than $50 million in sales.

Example

The San Francisco based company Song Do, is an importer and distributor of computerized embroidery machinery from a manufacturer in Incheon , Korea . The product is sold to distributors in the United States and Canada through manufacturer's reps. The company also operates a computerized embroidery business and has invested in machinery for this line of business. Although the business is marginally profitable, the company has begun a turnaround and booked over $1,450,000 in additional sales for the next year. A San Francisco bank provides the company a $1,120,000 line of credit but it is insufficient for their growing needs. The bank won't extend the line of credit and Song Do is beginning to have cash flow and related financial problems. The relationship with the bank has deteriorated to the point where their bank has suggested that the company consider other sources for financing.

TEFO introduces Song Do to an asset based lender who understands the company's industry. The lender sees a turnaround potential with the $1,450,000 in additional booked business and offers a one year revolving line of credit of $1,500,000. The asset based line of credit is combined with an Accounts Receivable Management service to monitor and administer the companies A/R and Inventory assets. The one year loan agreement specifies that loan cost will be prime plus 2% plus a 1.5% monthly fee on outstanding receivables and inventory for the life of the loan.

TEFO arranges with our Leasing Company, a sale-leaseback of 32% on the Machinery and Equipment. This gives the company a fresh cash infusion of $191,000.

TEFO teams up with a reliable commercial mortgage lender who does a 66% mortgage on the plant real estate at good rates. This provides $660,000 on a $1,000,000 building. This is another cash infusion of $180,000, since the current bank is only owed $480,000 on the plant real estate.

At loan closing, The Asset Based lender pays off the bank for their $1,120,000. Song Do now has $344,000 in additional cash available. In addition Song Do has a revolving line of credit that has increased to $1,500,000 based on receivables and inventory. This will enable Song Do to grow at a good rate without cash flow problems for some time in the future.

Features

Asset-based credits are secured by accounts receivable, inventory, machinery and equipment and sometimes commercial real estate.
No financing request is too large if supported by sufficient collateral
Asset Based Lenders emphasize more on liquidity and less on maintaining financial ratios.
ABL line of credit is normally set up with an annual maturity date.
An ABL line may be either a revolving line or a credit structured with a formal borrowing base with advances made on eligible assets.
Advances may range from 75% to 85% of eligible business receivables
ABL credits normally exclude receivables over 90 days from the invoice date, contra, foreign accounts and possibly government receivables.
Government receivables may be included if an assignment of claim is taken for each governmental agency.
Foreign receivable may be included if covered by foreign credit insurance such as Exim Bank's Export Credit Insurance Program.
Highest inventory advances are for finished product or raw material that is readily marketable.
The more sales and profits you generate, the more money you are advanced.
ABL line approval can normally be accomplished in 1-2 weeks.
ABL line funding can occur within 24 hours of request.

Prerequisites

Borrower company must be located in the United States
Firm must be currently profitable, or demonstrate a solid turnaround
The business must have a reasonable net worth and long-term viability.
Qualify with a minimum of $150,000 a month of good accounts receivable.
Qualify for a minimum credit line of $200,000.
Sell on open account to commercial customers. No consumer receivables.
Have accounts receivable that are well-managed and reasonably current, and/or other acceptable assets.
A reasonably professional management team with acceptable accounting practices
A product and business model that makes sense
Willingness to have assets audited
Borrower must submit a year's worth of monthly projections.
Periodic audits are required to determine the quality of the collateral
A fee is required to pay for the independent third party audit
Financial statements for the past three years
Interim financial statements (current within 90 days) may be required
Monthly or quarterly accounts receivable aging and payables may be required.
Financial statements may need to be reviewed by a certified public accountant
The business's principals may need to guarantee the loan.
Guarantee must be supported by personal financial statements.
Keyman life insurance may be required.

Asset Based Lending vs. Factoring

Asset Based Lenders (ABL) secures loan with accounts receivable (A/R), sometimes inventory, machinery and equipment, commercial real estate; factors purchase only A/R
ABL credits are normally lower than factoring rates.
In contrast to a Factor, the Asset based financing lender does not purchase invoices, but loans against a borrowing base of receivables, inventory and other assets.
The asset based financing lender advances a percentage of each invoice amount.
With Asset Based A/R Lending, companies are not notified when their A/Rs are financed as opposed to Factoring.
In contrast to a factor, the receivable ABL lender does not purchase your invoices. They advance you a percentage of each invoice amount.
ABL normally do not notify accounts receivable customers; factors do notify the customer

Asset Based Lending vs. Traditional Bank Financing

ABL focus on the collateral and liquidity of a borrower's business assets; Banks rely heavily on balance sheet ratios and cash flow projections as loan criteria.
Asset Based Lenders can usually provide substantially more funding than can be achieved from a traditional banking credit approach.
Asset based lenders are reliable and supportive during difficult economic turndowns; banks are infamous for lack of support in tough times.
ABL credit lines do not lock you into either a fixed loan or payment amount.
ABL provides greater liquidity and flexibility on use the loan proceeds
ABL requires fewer and less stringent financial covenants than traditional bank loans
ABL lending criteria is more liberal than traditional banks
With ABL prospective borrowers do not have to be profitable or have a minimum net worth.
With ABL borrowers pays interest only on the average daily outstanding balance.
With bank loans borrowers pay for loan commitments plus compensating balances
The cost of ABL is also generally more competitive than a secured bank loan.
ABL closely monitor borrowing base collateral and can therefore underwrite loans that are outside the typical lending criteria of most commercial banks.
ABLs are much more likely to accept borrowers with high financial leverage and marginal cash flows.
With ABL there is normally no monthly principal repayment
Unlike banks ABL lenders can increase credit line in the event that you take on a large customer or have a surge in sales.

Advantages To Importer

Asset based lending enables you to finance your business by leveraging the equity in your current and fixed assets.
Competition and a liquid market has made Asset Based loan costs competitive to traditional loans
Provides credit lines that flexibly grow to keep pace with your business requirements
Rapid cash advances to meet seasonal expenses, rapid growth cycles and acquisitions
Provides ability to smooth out cash gaps during business cycles.
Provides ability to fund growth opportunities, discounts for early payment etc.
Provides a flexible line of credit where a company may draw on the line only when and for the amount needed.
Assures access to a continuous source of working capital supporting virtually unlimited growth rate.
Secures cash infusion without diluting equity and control of the company.
Can lead to a traditional bank line of credit by establishing a positive credit relationship with a financial institution
Lender oversight of client's business and continual evaluation of cash flow and assets facilitates optimal credit availability.
ABL carries companies over seasonal periods or difficult economic cycles
ABL lenders are proactive and can restructure debt during tough times to help avoid costly and disruptive refinancing.

Disadvantages To Importer

Asset-based loans may be more expensive than traditional bank lines of credit
Though less costly than factoring ABL financing requires stronger financials
Collateral-monitoring requirements are much more intrusive on the borrower
Credit lines require continual servicing and monitoring of collateral
Additional fees may be charged by the lender.
When quantity and quality of assets are insufficient, cash flow financing may prove to be the most advantageous credit structure.
The quality of assets may adversely affect the loan rate.
Greater expense for reporting requirements and monitoring of assets.
Due diligence fee is commonly charged.
Businesses that generates large volumes of small invoices typically pays high monthly collateral-monitoring fees
Prepayment penalties are standard
Lenders may require daily reports on sales and collections to establish the level of qualified assets that a business can draw against
Finance companies subtract ineligible assets, such as past-due receivables to determine borrowers credit capacity
Asset based lenders will not normally loan on inventory alone but require accounts receivable in the asset mix.

Procedures

Company negotiates a one year revolving credit line with an Asset Based lender
The credit line is structured to lend against a borrowing base composed of 80% of qualified Accounts Receivables and 30% of Inventory.
The company sells its product or service to creditworthy customers.
The customers normally repay the receivables in 10, 15, 30 or 45 days.
The Asset Based lender makes a loan to the company according to the borrowing base.
Once the funds are advanced, the company starts paying interest on the loan.
The company's customers are instructed to send their payments directly to the Asset Based lender
The lender remits the invoice payments to the company, less the principal on loans it has already advanced, less interest.

Cost

In general, the greater the Asset Based lender's credit security, the lower the credit costs
ABL charge Prime Rate or LIBOR plus additional points based on the following factors:
- Credit risk level
- Amount of loan
- Type of assets provided for collateral
- Quality of asset collateral associated with the transaction

Typical Range of Advances on Assets

Accounts Receivable: Up to 90% advance on eligible A/R
Purchase Orders: Usually 60% of material costs plus labor

Inventory:

Raw materials 10 - 70%
Work in progress 10 - 40%
Finished goods 25 - 65%

Equipment: 60 - 75% liquidation / 80% purchase price
Real Estate: 70 - 75% of Appraised Value less mortgage

Determining Accounts Receivable Advance Rates

Asset Based Loans characteristically have much of the collateral support concentrated in accounts receivable. Lenders conduct a thorough analysis of the receivables at loan origination and periodically thereafter.
Receivables' advance rates vary depending on the nature of the receivables. While lenders usually advance amounts equal to between 70 percent and 80 percent of eligible receivables, lower advance rates may be warranted when there is heightened risk. Advance rates take into consideration dilution trends, diversification, and the overall quality of the borrower's customer base.
Lenders evaluate advance rates on an individual loan by comparing them with those on other loans in similar industries and to the same borrower over time. Loans with advance rates that are higher than the industry norm or historical benchmarks have heightened risk.
Lenders often raise advance rates to try to accommodate a borrower's need for more working capital. By the same token, very low advance rates may also warrant added scrutiny. ABL lenders will often reduce advance rates to build a collateral cushion if they feel that a liquidation may be imminent.
Much of the value or collectibility of receivables depends on the creditworthiness of the underlying customer. The lender's analysis of receivables usually begins with an evaluation of the financial strength of their borrower's customer base. In making this evaluation, lenders consider the following:
- Quality of customer base. In general, the greater the number of financially sound companies, the better the quality of the customer base.
- Concentrations. A customer base that has concentrations is riskier than one that doesn't. A concentration exists when a few customers produce the majority of receivables or when sales are made primarily to customers in one industry.
- Delinquency status. Lenders monitor delinquency trends within the accounts receivable base. Rising delinquencies indicate increased risk and may signal problems with the borrower.
- Dilution. Asset Based borrowers and their lenders are exposed to dilution risk - the possibility that non-cash credits will reduce, or dilute, the accounts receivable balance. Returns and allowances, disputes, bad debts, and other credit offsets create dilution.

Determining Eligible Accounts Receivable Collateral

Asset Based loan agreements usually specify that certain receivables are ineligible as collateral because of the type of receivable or the delinquency status. The following types of receivables are usually considered ineligible:

Government receivables because of the unique perfection and documentation requirements of the Assignment of Claims Act of 1940. Other possible reasons are: the government contractor or borrower may be subjected to strict specifications and rigorous inspections, the government entity may have liberal rights to return the goods, or the payment of government receivables often extends well beyond normal trade terms. If government receivables are eligible, the lender may permit a longer collection period
Foreign receivables because they have legal risks, foreign currency translation risks, and sovereign risks that can disrupt payment. Lenders may allow Foreign receivables to be eligible, but they will often require a letter of credit or an insurance policy carrying minimal deductibles.
Affiliate transactions because the financial conditions of affiliates may deteriorate simultaneously. Affiliate receivables can also increase the potential for fraud, particularly in times of financial stress.
Contra-accounts occur when a borrower both sells to and purchases from the same customer. Problems arise when the customer does a "set off" of the debt it owes against the debt owed to it and pays only the net amount.

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