The facts about asset based finance

Entrepreneur Thomas O'Connell received offers of investment from two of the tycoons on the BBC's Dragons' Den and rejected them both. The CEO of import and distribution outfit Atomic Sports says: "They were looking for too much equity. I turned them down and went off and got a better deal."

Anxious to secure funding without giving up a chunk of his business, O’Connell finally succumbed to the overtures of commercial finance specialist Bibby, which had first approached him over a year earlier.

Bibby took control of Atomic Sports’ debtor book, lending the company 80 per cent of the value of its unpaid invoices, then chasing down the outstanding balances for payment. In addition to this service, known as factoring, Bibby lent money based on Atomic’s confirmed orders.

O’Connell may have hesitated to take Bibby’s cash, but he’s had no cause to regret it. ‘There’s no way we could have afforded to take on our biggest customers without the facility,’ says the straight-talking Irishman. ‘Our turnover would be half what it is now and we would have lost distribution rights to some of our key products.’

It’s easy to find people with similar stories, like Gethin Roberts, MD of specialist recruiter Drivers Direct. When he set up his business five years ago, Roberts wanted to hit the ground running by opening three branches at the same time. He agreed a factoring deal with lender Venture Finance, allowing him to pay total wages of around £111,000 a week to drivers on temporary contracts, without having to worry about when each of his 500 clients was going to pay him. Drivers Direct has now doubled its number of branches to six. Roberts plans to expand this to 18 over the next five years.

Increasing usage

Broadly speaking, commercial finance is split into three areas: factoring, invoice discounting and asset finance. According to statistics released by the Asset-Based Finance Association (ABFA), the number of companies using factoring has more than doubled over the past ten years, and is now more than 22,000. It remains the most popular kind of commercial finance, partly because of its appeal to growing companies like Drivers Direct which do not have their own credit controllers.

See also: What is invoice finance and who are the top 5 lenders?

The unappealing aspect of factoring is that your clients know you’re using commercial finance to improve your cash flow, and the company chasing payment may be too zealous and forceful when dealing with clients you value. In many instances, the sophistication of credit control may be bluntly downgraded to debt collection.

This has given rise to invoice discounting. The service is similar to factoring except you can collect the debt by yourself so customers need never know you’re borrowing money. Furthermore, you control the relationship you have with clients.

Jeff Longhurst, the soon-to-depart chairman of ABFA and chairman of receivables specialist Eurofactor, says that the rise of invoice discounting has helped to change the industry’s reputation as the business world’s equivalent of loan sharks.

‘Factoring used to be known as “the lender of last resort”,’ admits Longhurst. ‘That was the image it had 20 years ago. The growth of confidential invoice discounting has played a part in changing that perception.’

One company heavily dependent on invoice discounting is Chartered Brands, which ‘runs brands’ for companies like Procter & Gamble and Unilever in the fast-moving consumer goods sector. Managing director Gervase Cottam says: ‘When I say we run brands, I mean that we provide finance, source manufacturers, develop products, sell, collect the cash and do the marketing.’

Cottam says that Chartered Brands’ clients sell to companies like Sainsbury’s and French supermarket Carrefour. These are ideal debtors for the invoice discounter because the risk of default is practically zero. As a result, the charges are minimal. ‘It’s a very small premium to the base rate, and slightly less than an overdraft rate,’ he notes.

There are limitations to such financing. ‘What it doesn’t do is finance investment in marketing, advertising and brand acquisition, which is a whole separate area of what we do,’ he says.

A changing perception

Chartered Brands, with its turnover of £25 million, hardly looks like a company on its last legs. Nor for that matter do Atomic Sports or Drivers Direct, which both demonstrate admirable growth.

They’re examples of how commercial finance can be used effectively. Loretta Fairley, head of marketing at invoice finance provider IGF, reflects: ‘Eleven years ago, I had a role on the end of a freephone number in the marketing department. Speaking to people, I did come across the attitude that invoice finance was for companies going down the pan. Now, instances of that attitude are few and far between.’

Of course, there are factoring clients that go bust, Fairley acknowledges, but she doesn’t see a connection with their use of the service. ‘If the company isn’t trading and raising invoices, there’s nothing for us to fund against so inevitably it’ll go down the pan,’ she adds.

Longhurst has a slightly different view. ‘A typical company [using invoice finance] with a turnover of £5 million might have two or three customers on which it is especially reliant for growth. If it lost one of them, it might lose 20 per cent of its turnover. So it would also lose 20 per cent of its borrowing capacity, with the knock-on effect on cash flow.

There’s always a risk if you’re using too much of the facility and your turnover is falling. ‘Of course, if you’re in that situation you’ve got problems anyway, with or without finance. But it might just bring them on a little sooner.’

The bottom line is that if a venture is haemorrhaging customers, seeking commercial finance will only prolong the death throes of a business. However, if you’re gaining customers and waiting on payments to be made, it can revitalise and invigorate your plans for growth.

Bigger fish to fry

If your company has loftier aspirations than freeing up cash flow, such as making an acquisition, and yet you’re reluctant to release equity to a VC, other types of borrowing are available.

Earlier this year, chemical distribution business 2M Holdings acquired liquid specialist SurfaChem. 2M’s co-founder Mottie Kessler explains that the only external funding for the deal came from debt. ‘We looked into the cost of asset-based finance and invoice finance, and eventually went for a mixture of the two,’ he says.

In the event, 20 per cent of the debt was secured against property (2M also owns 150-year-old chemical distributor Banner Chemicals), and 55 per cent against outstanding invoices. The balance came from so-called “cash flow lending” – in other words, money advanced on the expectation that past profitability will continue, allowing the company to service the debt.

Peter Smith of Yorkshire Bank, who helped structure the debt package for 2M, says that the number of specialised asset-based lenders in the market has grown rapidly over the past few years, putting pressure on traditional banks.

‘We’ve seen a lot of new players come in, doing a lot of deals,’ he states, noting that he’s not overly impressed with some of what he’s seen. ‘I’ve lost two transactions, worth about £10 million each, where I know I was in competition with asset-based lenders. In one case, the management team had said to me: “We’ve got £300,000 to buy a business for £13 million.” But the asset-based lender had told them: “Just give me £10,000 and I can fund the rest.”’

It leaves Smith nonplussed. ‘Being a traditional banker, I sometimes can’t understand how they’ve leveraged so much,’ he comments.

Longhurst confirms it’s an aggressive environment. ‘It’s very, very cheap lending and I wish it wasn’t!’ he says ruefully. ‘But the market determines what we charge.’

Asset-based loans might cost less than one per cent over the Bank of England’s base rate, according to Longhurst, compared with the 2.5 to three per cent normally offered by invoice discounters. He adds: ‘The bigger the deal, the less you pay, because you can demand lower fees in this hugely competitive industry.’

In addition to offering lower fees, lenders are expanding the definition of an asset. Formerly, only tangibles like property, machinery and stock were regarded as adequate security. Now, in addition to unsecured cash flow lending, the industry is looking at intangible assets such as brand, staff and intellectual property.

Thayne Forbes, joint MD of Intangible Business, is a specialist in this area. ‘Take a business like cognac,’ he elucidates. ‘You might have 12 years’ worth of stock, which has a high value. But it’s worth even more if you can put a brand name on it. So securing a loan against stocks of cognac works better if you can secure against the brand as well as the hard asset.’

Easy money

The latest figures from ABFA show that companies have not been slow to take advantage of cheaper, more convenient borrowing. The association’s members are currently owed £14 billion by their clients – up from £11.6 billion a year ago.

Nevertheless, the industry maintains that neither invoice discounting nor asset-based lending are riskier for the borrower than any other kind of loan. The danger is not in the type of borrowing but the amount, says Yorkshire Bank’s Smith: ‘[Lenders] are not only gearing up against assets like the debtor book, stock and property, they’re now also putting in a level of loan against future cash flows, which is unsecured.

‘In that situation, there’s not a big buffer to allow for a downturn. The proof of the pudding will be whether companies struggle to service the transactions when interest rates go up.’

Clive Lewis, head of SME issues at the Institute of Chartered Accountants in England & Wales, argues that companies with minimal debts and healthy bank balances are best able to withstand a downturn in trading.

‘Very often, in difficult times you should think about your cash situation first,’ he counsels. ‘If a big order comes through that requires an injection of working capital, more stock and more debtors, there might be a case for declining the opportunity.’

Naturally, the flip side of the argument is put forward by Peter Ewen, finance director of Venture Finance. ‘A lot of the businesses we deal with are highly leveraged, but if they weren’t they would find it difficult to succeed at all,’ he remarks. ‘What the industry is doing is giving businesses an opportunity to succeed. If we didn’t do that, nobody else would.’

Related: How does asset-based lending work in the UK versus peer-to-peer?

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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