Firms have a range of financing options to drive their business. Peter Jump finds out how asset-based lending and other forms of finance can open up new vistas for companies by improving their access to capital.
All the recent talk of a credit crunch and a possible slowdown in the economy may be leading many South West CEOs to think about reining in their ambitions for world domination.
After all, without ready access to relatively cheap money, mergers, acquisitions, buyouts and the like aren't likely to be feasible. And even organic growth may have to be put on hold if there's a lack of funds to plug the gap between income and expenditure that rapid expansion often creates.
But before hitting the brakes, there are a raft of financing options based around borrowing against a company's assets that might allow you to continue to steam ahead. Collectively referred to as asset-based lending (ABL), these financing possibilities can be a way for successful businesses to magic up money when it's most needed, either for growth or to help finance a deal.
As a class of lending, ABL encompasses factoring, invoice discounting, asset financing (for example, against stock and machinery) and cashflow loans. Some of these trade finance options, especially factoring, still conjure images of desperate companies in the early 80s trying to stave off bankruptcy. But such negative associations largely stem from misunderstandings, even among financial directors, as to what they involve and how they can be best used.
Indeed, these days even big-name multinational corporations aren't above turning to ABL. US financial services company JP Morgan regularly provides hundreds of millions of pounds of such funding to its European clients. Its managing director for ABL in London, Paul Hancock, says the use of ABL is an increasing trend "because it's a source of finance if corporations have an uncertain earnings outlook. Financial institutions are more comfortable lending on assets".
Invoice financing By far the most common asset that companies lend against is their sales ledger, with lenders advancing up to 90 per cent of its value. Such invoice financing takes the form either of factoring or invoice discounting.
"Today, over 43,000 companies in the UK are using some form of invoice finance," says James Benson, managing director of FDUK, a provider of part-time finance directors.
"Factoring companies, or factors,will buy your company's debt at a discounted rate and then collect it themselves. They will then pay a fixed proportion of the outstanding invoice within a pre-arranged timescale.
"Invoice discounting has many similarities to factoring. However, the company retains the responsibility for chasing payment from its customers."
An advantage of factoring for small, growing businesses is that it can remove the need to set up a credit control department. A negative is that your customers will know you are using a factor. Invoice discounting, however, can be set up confidentially, without the customer being aware.
"Funding through invoice discounting or factoring will grow with the business as more invoices are sent out," says Benson. "The lender will be able to release more funds, providing the business with more working capital - bank loans do not have this level of flexibility."
Of course, effectively having your invoices paid a day or so after they are issued comes at a price. Firstly, there is interest on the money advanced to you which is typically between 1.5 per cent and 3 per cent over base rate, followed by a service charge which is a percentage of turnover.
"The service charge will be in the range of 0.5 per cent to 2 per cent for invoice discounting and 1.5 per cent to 5 per cent for factoring, although this is very general and should be taken as an indication only," says Benson.
Helping the Deal Supporting organic growth by improving cashflow is one of the more obvious benefits of ABL, but it also has an increasingly important part to play in the deals process.
Matt Eves, a senior manager with Target Corporate Finance in Bath, says: "ABL was once viewed as a last resort for companies seeking finance, but in the past few years lenders have become much more sophisticated and perceptions have changed. It is now seen as a real alternative to mainstream sources of funding.
"Unlike venture capital, with ABL there is no need to give away equity in the business, so it is popular with managers who are seeking flexible finance but want to keep full control of the company. Because funds are secured on assets rather than cashflow, there is provision to increase the debt in line with the growth of the business. It is also easier to access finance in times when cashflow is tight."
Meanwhile, Rob Crews, co-founder of Bristol deal boutique Momentum, says: "Trade finance can be an extremely useful element in funding management buyouts and acquisitions. We have advised on several deals utilising trade finance, the most notable being the £318.5m management buyout of Bristol-based Integral Services from Staveley Industries. Due to Integral's large level of debtors, Lloyds TSB Commercial Finance was able to provide an attractive debt package secured on the trade debtors of the business. As Integral has continued to grow, the trade finance available to it has also expanded."
Talking more generally, Crews says: "The key attraction of trade finance is that since it is usually secured on the regular ongoing levels of debtors or stock, it typically only requires interest payments to service it. This is in contrast to a typical term loan based on the cashflows of the business which would require both interest and capital repayments on a regular basis, to reflect the increased risk to the lender. This means that to raise any given level of debt, trade finance should place a lower cashflow burden on the business, as compared with using a traditional term loan. In a management buyout this means that the management team should receive a better overall deal through being able to source a higher level of cheaper debt."
These comments might lead one to think that venture capitalists are averse to ABL, given that it may reduce the amount of equity they are able to grab as part of a deal. However, Kate Sharp, chief executive of trade body The Asset Based Finance Association (ABFA), says: "In the US, equity providers increasingly like to have an ABL piece included as it gives them a better feel for how the business is running."
The "better feel" stems from the fact that asset-based lenders by necessity need to keep a close eye on how the firm's sales ledger is doing, with audits every few months. However, Stuart Crebo, Ernst and Young's corporate finance director in Exeter, says there is a more fundamental reason for venture capitalists liking ABL: "For a venture capitalist, the more senior debt that can be put into a deal before killing it the better."
ABL will not only be generally regarded as senior debt, but will be lent at far higher levels that a normal bank loan.
"ABL will give you greater leverage than a normal senior piece in a funding deal," says Sharp, with the added bonus that it is "covenant light".
By this Sharp means the asset-based lenders won't have the same requirement as other lenders for assurances on how the business will develop. That's because their main concern is the value of the assets they are lending against, not how well managers are doing sticking to their business plan.
Sharp feels it is ABL's ability to provide more money, but with fewer strings, that has led to its slightly shady reputation. "The industry still needs to improve people's understanding of ABL," she says.
Part of the mix Having established ABL's potential, it is important to also realise that, as with any other form of lending, it must be used appropriately.
Ernst and Young's Crebo, who is a former banker, warns: "Make sure to match up the finance to a specific asset you are financing. Mismatching the asset to the liability by a bank will get you a short-term solution to a long-term problem."
It would be inappropriate, therefore, to use invoice discounting to fund a capital project, such as building a factory, Crebo says. "Acquisitions could be funded by an invoice discounting line, but if debtors start to shrink you no longer have money for the acquisition. So you'll need to consider long-term debt such as a 15-year mortgage, which will result in a further mismatch," he says.
"Asset finance shouldn't be used for acquisitions, but to support acquisitions."
(See the Ultimate Finance box for an alternative view on this.)
That means using ABL principally to help alleviate the strain on cashflow that can follow a deal, as the company buys extra stock, takes on staff and does all the other things needed to achieve strong growth.
And Momentum's Rob Crew echoes Crebo's warning: "Trade finance does have risks, the principal one being that if a business experiences difficult times then the level of debtors or stock may well be reduced due to those trading difficulties. As such the finance available to the business will also shrink (because it is linked to the underlying assets of the business), potentially at the time when flexibility of funding is most required.
"The best approach is to always structure any form of debt with a sensible level of headroom at the start - which means that the business is not over-burdened with debt and can cope with the ups and the downs of the economic cycle."
Not for everyone At the same time, it should be noted that ABL isn't appropriate for every kind of business.
"Invoice discounting is sometimes difficult when you have a contract with staged payments," says Matt Hatcher, head of Royal Bank of Scotland's leveraged finance team in Bristol. That's because a dispute can easily result in non-payment situations that are difficult to resolve.
This does mean certain industries, most notably construction, are generally avoided by asset-based lenders.
Hatcher also says that those companies that are reliant either on a small number of customers, or else quite dependent on a single large customer might they will be lent considerably less than 90 per cent of their invoice values.
FDUK's Mike Pawley sums up the situation with regard to invoice financing by saying: "You need a clean sales ledger when you start this. If there are lots of disputed or old debts it can be a problem and lead to a reduced facility. It is not a way of dealing with these problem invoices.
"You need a high-quality business to start with - and would-be funders will look at your business before taking you on," he says.
Of course, no finance-related discussion would be complete these days without some reference to what effect the so-called credit squeeze may soon have. As mentioned at the outset, one question is whether ABL is a way to overcome the current scarcity of debt.
"What we would expect in a credit crunch is that invoice finance would go from strength to strength as banks get stretched and close their door," says ABFA's Sharp. "Our members are telling me we've still got money to invest."
Given that Sharp works for the asset-based lenders' trade association, his positive outlook is perhaps to be expected, so the last word goes to Target's Matt Eves. He says: "Over the past year we have seen quite a few private equity transactions which were backed by ABL. As the credit markets become tighter, more and more companies are likely to use ABL to fund their growth strategies. However, businesses that are considering this option should do their research and find a lender that shares their approach to risk and with whom they feel they can maintain a long-term relationship."