Some businesses thrive during recessions. While everyone else is struggling and worried about the future, these counter-cyclical businesses show truly defensive qualities. Just about now, the tranche of major asset-based lenders (ABLs) is rubbing its hands, dusting down its sales pitch and getting on the front foot, albeit with a slightly nervous air of anticipation.

ABLs, such as GMAC Commercial Finance, Bank of America Business Capital Europe and Burdale Financial, have been overshadowed over the past few years by those groups eager to offer leveraged borrowing based upon multiples of earnings before interest, tax, depreciation and amortisation (EBITDA) and cash flow models.

These latter lending models are more uncertain and more aggressive than the safety-first approach of ABLs; thus a company can obtain larger amounts of financing using a cash flow approach than is possible through asset-based lending.

While ABLs have not been at the forefront of the tidal wave of borrowings since 2000 that has been promoted by the financial engineering of private equity businesses and other groups, they are now expecting that businesses looking to fund future growth over the next couple of years will be taking a long hard look at deploying ABL to solve their problems – whether for new finance, for refinancing of existing borrowing based on more aggressive models, or for recovery and turnaround solutions.

See also: How does asset-based lending work in the UK versus peer-to-peer? – Asset-based lending is a medium to long-term solution that is suitable for a range of commercial situations. Relationships and expertise are at the heart of any solution. By contrast, peer-to-peer lending often requires less of a time investment up front or has lower ‘entry’ requirements.

“The de-leveraging process has been violent and the landscape has changed,” comments Phil Lammas, sales director of GMAC Commercial Finance. “When we emerge from this period, ABL is going to be the key form of lending. It is a safe harbour in a storm.”

IN STASIS
ABL is an exact description – the lending is secured on assets such as property, plant, stock and debtors – and it is very appropriate for certain sectors, such as manufacturing or retailing. Typical interest rates are quoted as three per cent over LIBOR (and rising).

However, while current interest levels in asset-based lending are rising, as yet, any activity is not turning into hard deals. Currently, the major players have not swung into action with the expected stream of deals.

“Back of last year, we had a flurry of enquiries when the problems in the Icelandic banks first occurred,” says Tanya Grubic, senior business development officer for Bank of America. “Many UK companies were clearly concerned about their lender’s financial difficulties. Since then, I’m a little surprised that volumes [of transactions] have not been higher.”

Word is in the accountancy and recovery professions that in a typical economic cycle, as the numbers of mergers and acquisitions fall, the slack will be picked up by greater activity in reconstructions and recoveries. But there is currently a hiatus. Like many other sectors of the economy, decisions, even about refinancing or restructuring, seem to be on hold until the clearing banks can pause for breath.

The banks have been hit by a “gale”, and while they are picking themselves up, everything seems to be standing still. Not, of course, administrations – these are occurring with frightening frequency – but as Grubic remarks, “Companies going into administration will only provide opportunities for ABLs where there is a valuable business that will emerge.” However, she adds, “A lot of refinancing opportunities are likely to emerge as a result of clearing bank decisions.”

NOT ALWAYS A FIT

Not every financing deal will be suitable for ABLs – and there needs to be a sea change in attitude by existing lenders, for example, before any deals can be crystallised. ABL is not suitable for companies that are mainly “people” businesses and whose assets are largely intangible, such as media or consultancy businesses.

Steve Chait of Burdale Financial explains, “The days of pushing the envelope with, for example, funding 100 per cent of debtors and an aggressive cash flow deal are gone. ABL is not so focused on earnings, but more on assets, and cannot get near the amount of debt done through the leveraged EBITDA deals.”

Thus, in a refinancing, for example, there is a shortfall against the amount of existing debt. Continues Chait, “We’re looking at a deal right now where there is a shortfall – the existing lender doesn’t want to take a haircut and is trying to get the owners to put in more equity. The time will come when something has to give [and existing lenders accept a substantial write-down].”

However, Lammas warns that it can still be difficult for ABLs to secure their loans against some assets in the current climate: “Plant and property are tricky to lend against now as values are still falling, while receivables and inventory can provide an acceptable security.”

Asset-based lending has historically been regarded as the lender of last resort, but Lammas argues that the ABLs offer a different range of experience and expertise compared with, say, the clearing banks. The lenders have extensive knowledge of the difficulties and pitfalls of making a successful turnaround. They provide the catalyst for companies in difficulty to impose more rigid systems and better discipline and control over their finances.

The lenders such as Burdale and GMAC expect that, during this recession, especially for the major deals, the group of lenders will be working together in a “club” to ensure that the deals can be completed and the risk spread. Summarises Grubic, “The challenge for ABLs is to be patient and wait for the right opportunities, and to be careful about the opportunities. We need to ensure that the advisers are educated about ABL and understand the difference between it and the recent more prevalent cash flow-based lending.”

BURWOOD MBO

Burwood Fasteners was bought by its management last year in a deal backed by Bank Leumi. The Surrey-based company is a classic part of the UK’s manufacturing heritage (founded in the 1930s) and therefore, in essence, a good candidate for ABL.

“This was a really unusual deal,” says Gavin Maitland Smith of Gower House, who specialises in arranging working capital finance and helped to organise the funding with Bank Leumi.

“Burwood is essentially a stockholding business for the aircraft sector – not major items, but small bits [such as nuts, bolts, screws, rivets and washers].”

Burwood holds high levels of stock. In addition, the company had bought a lot of stock at knockdown prices from businesses in administration, which meant that the real value of the stock was a lot higher than its book value. A lot of work needed to be done in appraising the stock value.

As a result, continues Maitland Smith, “It is one of the only ABL deals that I know of in which the advance on the stocks was higher than the advance on the debtors. In addition, deferred consideration was agreed because there was a gap between what could be raised and the purchase price of the business.

Finally, a further difficulty was that, historically, the business had been owner-managed, so finding a lender wasn’t easy.”

Although the deal was a small one, it had some of the complexities of a much larger fundraising.