Asset-Based Lending (ABL)

Standard formula: Borrowing Base = (Eligible AR × 85%) + (Eligible Inventory × 50%) + (Eligible Equipment × 75%) - Reserves. Calculated monthly (for stable companies) or weekly/daily (for stressed or seasonal companies). Example: $50M AR (all eligible), $40M inventory ($35M eligible after adjustments), $10M equipment ($8M eligible). Base = ($50M × 85%) + ($35M × 50%) + ($8M × 75%) - $3M reserves = $42.5M + $17.5M + $6M - $3M = $63M borrowing capacity.

AR eligibility tests: Excludes receivables over 90 days old, receivables from affiliates or employees, government receivables (unless specifically allowed), concentration over 20% to single customer, receivables with disputes or offsets, cross-aged or recategorized receivables. Typical result: 80-90% of total AR qualifies as eligible.

Inventory eligibility: Excludes obsolete or slow-moving (over 365 days old), work-in-progress, finished goods not saleable in ordinary course, consigned inventory, inventory subject to third-party liens, inventory stored off-site without field warehouse receipt. Often 70-85% of total inventory qualifies as eligible.

Reserves: Lender-imposed reductions for rent (3 months), customer credits, priority tax liens, dilution (typical 1-3% of AR for returns/discounts), seasonal requirements. Reserves can total $3-10M on $100M facility reducing effective availability significantly. Lenders can increase reserves unilaterally if perceived risk rises.

Daily/weekly reporting: Borrowers submit borrowing base certificates weekly (sometimes daily during stress). Reports include detailed AR aging, inventory rolls, sales data, collection activity. Electronic systems feed bank portals with real-time data. Late reports trigger default provisions and availability reductions.

Blocked accounts (lockbox): All customer payments flow to blocked accounts controlled by lender. Lender sweeps collections daily to pay down outstanding advances. This 'dominion trigger' activates upon any covenant breach or availability shortfall. Creates tight cash control—borrower loses access to receipts during stress.

Field exams: Lender conducts on-site audits 1-2 times annually (quarterly for stressed borrowers). Third-party specialists physically inspect inventory, verify AR through customer confirmations, test eligibility categories, assess collateral quality. Exam findings often trigger advance rate reductions or reserve increases. Cost $25-50K per exam charged to borrower.

Appraisals and valuations: Equipment appraised at origination and annually thereafter. Inventory liquidation values assessed. AR quality measured through collection history and dilution analysis. If values decline below advance rates, lender forces availability reductions. Example: Equipment appraised at $10M supporting $7.5M advances. New appraisal shows $6M liquidation value → advance limited to $4.5M, creating $3M availability squeeze.

Security and priority: ABL first priority lien on current assets (AR, inventory). Often super-senior to term loan secured by fixed assets. In bankruptcy, ABL lenders receive collections directly from blocked accounts before other creditors participate. Cash flow lenders have first lien on all assets but lack operational controls ABL provides.

Availability mechanics: ABL provides $60M available against $75M eligible collateral (80% advance rate). Borrower can draw/repay flexibly as working capital needs fluctuate. Cash flow revolver provides $50M commitment based on 3.0x leverage ratio. Borrower tests leverage quarterly—if violated, revolver unavailable regardless of collateral quality.

Covenant structure: ABL typically requires minimal FCCR (1.0-1.1x) with no leverage test. Extensive eligibility and reporting covenants. Cash flow loans have multiple financial covenants (leverage 4.5x, FCCR 1.2x, capex limits) but lighter operational requirements. ABL more suitable for volatile EBITDA businesses where collateral coverage matters more than earnings tests.

Pricing: ABL typically L+200-350 on outstanding balances plus 0.375-0.50% commitment fee on undrawn. Cash flow revolvers often L+300-450 with similar commitment fees. ABL appears cheaper but requires more fees (field exams, appraisals, collateral monitoring) adding 25-50 bps all-in. Total cost roughly comparable but ABL provides more flexibility and larger size.

Seasonal business dynamics: Retailer borrows $50M in September building holiday inventory. Availability increases as inventory purchased. December sales convert inventory to AR, maintaining high availability. January collections pay down borrowings to $10M. February-August: low borrowings ($5-15M) on minimal inventory/AR. Borrowing base flexes with business cycle—perfect working capital management.

Distressed company scenario: Troubled manufacturer with declining EBITDA can't access cash flow lending. Has $60M AR, $50M inventory, $20M equipment. ABL facility provides $75M availability (assuming 85%/50%/75% advance rates). Company uses ABL to fund operations during restructuring. Lender protected by daily monitoring and 20-30% collateral cushions. Eventually company stabilizes or sells in 363 bankruptcy—ABL lender recovers 95%+ of exposure.

High-growth cash burners: Tech-enabled logistics company with negative EBITDA but $100M AR, $40M inventory. Cash flow lenders won't provide facility (no positive EBITDA). ABL lender provides $90M facility against strong collateral. Company uses ABL for 3-4 years until profitable, then refinances into cheaper cash flow facility. ABL bridges growth phase when collateral strong but earnings negative.

Availability squeeze scenarios: Company has $100M facility, $80M outstanding. Sudden inventory write-down ($10M obsolescence), AR aging deterioration ($5M over 90 days), dilution spike ($2M customer deductions). Borrowing base drops from $90M to $73M. Company immediately over-borrowed by $7M. Must scramble to find $7M cash to pay down or face default. This 'availability cliff' creates liquidity crises even when business otherwise stable.