Asset Based Loans – Counter Cyclical Liquidity Enhancement

Posted on: October 6th, 2021

asset based loans

All businesses go through cycles which require various levels of investment along their growth journey. Starting out, businesses need venture capital to build the product and attain market validation. Once proven, businesses need growth equity or growth debt to jumpstart their commercialization roll out.

As the business continues to expand, more scale-up capital in the form of debt or equity is used to diversify the product line and market. Along this classical growth path, there are interruptions caused by the macroeconomy which slow or even halt growth, despite a Company’s best efforts. The profit trend may turn red, making it difficult to raise capital based on the strength of the Company’s historical performance. As the Company becomes loss-making, pressure builds on its balance sheet, eroding its current assets and ballooning its payables.

Most companies try to ride out this cycle, yet the longer it goes, the greater the potential harm. A smarter, more enlightened approach is to directly address the capital shortfall by using an asset-based loan, as a counter cyclical form of liquidity enhancement. Most companies see loans such as asset-based loans in a pro-cyclical manner, used only when business is strong. Asset based loans certainly add value in accelerating a company’s growth, but they bring even more value in buffering a company’s liquidity and breaking the cycle of deceleration. Asset based loan proceeds have big impact in helping to reverse a company’s downtrend through remedying capital shortfalls and enabling the company to reliquefy.

Asset based loans are made, as the name implies, against the assets, and are available from lenders with special understanding of the collateral value. Even through your business trend is down, the collateral value of your assets is not necessarily impacted. If your business is not in a state of near-term insolvency, asset-based loans are available to serve as a bridge over troubled waters. They can be used to repay old bills, buy more product, or gap fund any other budget areas. Capital infusions have their greatest impact when calibrated with the right timing. Using asset-based loans to address working capital weakness is a strong counter-cyclical, liquidity enhancing maneuver

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.