The Benefits of Asset-Based (ABL) Lending

Key takeaways:

• ABL offers flexible, collateral-backed financing for growth or recovery.
• ABL provides more resilient access to capital with fewer restrictive covenants and better liquidity management.
• Cost efficiency is a major advantage, with ABL loans typically priced lower than high-leverage alternatives.
• Strong lender partnerships and structured oversight make ABL a reliable option for middle-market firms.

How ABL supports growth and stability

The challenges facing middle market companies because of current economic volatility can be extremely difficult to navigate. While some companies lack working capital to build inventories, others are growing in the current environment and need financing to help spur further growth. For many firms, a solution to these challenges is asset-based lending.

What is asset-based lending?

Asset-based lending (ABL) has long thrived in both good times and bad as a financing solution for companies with large inventories and working capital needs. "Asset-based lending is a flexible financial solution that is able to provide credit through the credit cycle and the life cycle of a company," said Richard D. Gumbrecht, CEO of the Secured Finance Network. "As economic uncertainty has increased, we’re seeing businesses once again turning to asset-based lending for the financial capital they need to remain viable and competitive in the face of uncertainty."

What is an asset-based loan? As the name implies, asset-based lending is a business loan option that is directly correlated to the value of a company’s assets, which serves as the lender’s collateral for the loan. Once regarded as creative financing for troubled companies, private equity and investment banks began using asset-based lending to finance larger leveraged deals. This was a game changer for the industry.

Today, asset-based loans are well-collateralized, competitively priced vehicles that are effectively used by companies of all sizes for acquisitions, growth, turnarounds or to simply support working capital needs. "Asset-based lending is a great financing solution for companies with diverse needs, providing flexible credit facilities that leverage their assets effectively—especially for businesses in manufacturing, distribution and retail," noted Steve Pomerantz, Asset Based Lending Group Head for Fifth Third Bank.

Overall, ABL parameters rarely deviate—no matter the market conditions.

ABL vs. cash-flow financing

One of the biggest differences between ABL and cash-flow financing is how each handles loan covenants. ABL structures lean on collateral to support their financing exposure, making them less restrictive and easier to manage. This flexibility allows businesses to maintain access to capital during periods of financial stress, making ABL a more resilient option during uncertain times.

In contrast, cash-flow lenders often base underwriting on performance metrics like Total Debt to EBITDA and Debt Service Coverage. When performance declines, this ratio can deteriorate quickly, triggering covenant issues and limiting access to capital.

ABL lenders take a different approach: they start by analyzing the liquidity of a company’s asset pool and building a credit facility based on advances against those assets.

Structural differences in lending

Another key distinction lies in the loan structure.

Many cash-flow lenders favor term loans, often seeking to minimize revolver sizes. While ABL lenders also offer term loans, most specialize in providing and administering revolving lines of credit. This revolving structure gives businesses ongoing access to liquidity, which is especially valuable for highly seasonal businesses and during periods of fluctuating demand, or economic uncertainty.

Some business financing lenders will also provide revolvers in conjunction with a treasury management relationship, making it easier for companies to manage various aspects of working capital and cash cycles.

What are the cost advantages of ABL?

Another attractive feature for companies considering ABL is cost.

Because most ABL loans are collateralized and covered by assets with a perceived lower risk profile, they’re typically 100 to 200 basis points cheaper than high-leverage cash flow loans. They also come with lower closing fees, making them a more affordable option.

This cost efficiency makes ABL an especially attractive option for companies looking to preserve capital while maintaining access to flexible financing.

Better prepared when challenges arise

In addition to cost savings, ABL also offers operational advantages that become especially valuable during periods of financial uncertainty.

Having pushed the limits on leverage, many cash-flow lenders tend to protect themselves with a covenant default. ABL lenders, however, are set up to monitor loan exposure continuously, often on a monthly basis. This consistent monitoring allows them to become intimately familiar with working capital cycles of borrowers and are better prepared to react quickly and work with clients when unique challenges arise.

While ABL reporting requirements may create some additional administrative work, shareholders and management see this heightened level of oversight as a valuable supplement to their own financial tracking, particularly in volatile times.  The same can be said for junior lending partners who know the ABL lender is paying close attention to liquidity dynamics.

A team approach

ABL, when paired with a non-bank term loan, "last out" term loan or subordinated debt, may be a safer approach for many middle-market businesses. Compared to large, cash-flow term loans with one lender, this approach may offer a lower overall risk profile and support for capital preservation.

Being able to turn to a team of lenders with deeper resources, as opposed to one lender, also may mitigate risk in executing strategies in a company’s future—whether that’s navigating through a crisis or pursuing growth.

How strong partnerships drive success

The proof of this strategy can be seen in the strong relationships built over the years between ABL lenders and non-bank partners. These relationships offer benefits for all participants:

• For borrowers, this two-tiered debt approach can be a benefit. Lenders with a history of completing financings together often have legal document templates in place and know each other’s processes and work styles. This lowers the risk of lengthy or failed loan execution.
• Non-bank debt providers gain comfort in knowing an ABL lender is closely monitoring a borrower’s business trends and is more likely to act pragmatically in a crisis.
• ABL lenders appreciate that the non-bank lender is often proactive with management and ownership and may even hold a board seat or have observation rights.
• Lenders with existing relationships provide for effective lines of communication, a lack of confusion and rapport with the management team that benefits all.

Financing growth with flexibility and resilience

Middle-market companies continue to face a complex mix of economic headwinds and strategic uncertainty. From elevated interest rates and inflationary pressures to geopolitical tensions and shifting trade policies, many firms are reassessing growth strategies and focusing on financial resilience.

In this environment, ABL structures may be a more prudent way to finance acquisitions, particularly for manufacturing and distribution companies. The equity gap to be filled may not be materially different than a cash flow structure as purchase price and leverage lending multiples pull back in response to volatility created by supply chain disruptions and inflation.

As companies seek stability, industry leaders point to ABL as a proven solution. According to an article from Business Wire, Gumbrecht shares that, “ABL has long been seen as an all-weather product and today’s volatile market conditions reinforce its role as a dependable source of capital in uncertain times.”

Looking ahead, the distressed buyout market may eventually heat up. Here, too, there is a role for ABL structures, which always lead with a revolving line of credit. Draws against revolving lines of credit have several under-appreciated features in the absence of scheduled principal amortization and the borrowing base expansion that accompanies growth in sales, which provides added liquidity without a term loan.

These features can lower fixed charges, making it easier to meet covenants and free up cash flow to reinvest in a recovering or growing business.

In conclusion

As businesses look to the future, ABL may be the answer to solid execution for sound and strategic planning—for both companies and their advisors. As organizations begin to reposition themselves for growth and stability, ABL can be a powerful tool, particularly for manufacturing and distribution companies and capital-intensive industries. The capital structure can be diversified, borrowing capacity can be freed up for other purposes and businesses gain a source of working capital.

To find out more about asset-based loans, contact a Fifth Third Bank ABL specialist to discuss your unique financing needs and options.