Asset-based lending

Cash flow loans are sized on EBITDA. An asset-based loan (ABL) is sized on what the lender could collect or sell if it had to: the borrower's receivables (invoices customers owe), inventory, and sometimes equipment and real estate. It's usually a revolving line the company draws and repays as its business moves.

The amount it can draw is the borrowing base: each kind of asset times an advance rate. Receivables are the best collateral, because customers pay them within weeks, so advance rates are high, often around 80% to 90% of eligible receivables. Inventory is harder to turn into cash, so it gets less: often around 50% to 65% of cost, or up to about 85% of its net orderly liquidation value (what an appraiser thinks an orderly sale would raise after costs). Equipment and real estate get lower rates again, based on appraisals.

Not every asset counts. Typical ineligible receivables: invoices more than 90 days past their date, amounts owed by the borrower's own affiliates, some foreign customers, and the part of any one customer's balance over a concentration limit. Inventory that's obsolete, in transit or held by someone else is often excluded too.

receivables = 20_000_000
ineligible = 3_000_000          # over 90 days, affiliates, over the limit
inventory_cost = 16_000_000
base = (receivables - ineligible) * 0.85 + inventory_cost * 0.50
commitment, drawn = 25_000_000, 18_000_000
availability = min(base, commitment) - drawn
print(round(base), round(availability))

Availability is what the company can still draw: the lower of the borrowing base and the line's size, less what's already drawn. Many ABLs have a springing covenant: a fixed-charge coverage test that only applies if availability falls below a set level, so a healthy borrower isn't tested at all.

Because the collateral is the point, the lender checks it constantly. The company sends a borrowing base certificate (monthly, or weekly if things are tight). Field exams send examiners to test the receivables and inventory records against reality, and appraisers value inventory and property. Customer payments often go to a bank account the lender controls, and the cash pays down the line.

ABL suits companies with lots of receivables and inventory and thin or uneven earnings: distributors, manufacturers, retailers, seasonal businesses, and companies going through a rough patch. A software company with little inventory and few physical assets is a cash flow borrower, not an ABL one.