Making assets work

Instead of taking out a traditional overdraft to fund expansion and R&D, asset-based financing offers manufacturing firms a way to convert balance sheet assets into operating cash. Mark Venables explains.

In the ever-changing world of business finance, there is a new kid on the block in the form of asset financing.

The essence of asset financing is simple. Instead of taking out a bank overdraft or loan for operating capital, you borrow money on your existing assets; unencumbered plant, equipment, property and book debts. It is even possible to borrow on your intellectual property (IP).

The core principle behind asset-based lending opportunities is that they exactly match the funding requirements of the business against assets on the balance sheet. The difference from traditional leasing and hire-purchase is that you use the funding from existing assets to secure new ones, to expand, or even fund R&D.

‘The increasingly strong regulatory environment has contributed to the growth of asset-based lending in the UK,’ said Andy Martin, head of manufacturing for Barclays. ‘Regulation around issues such as preferred creditors and retention of title are better dealt with by asset-based finance than the more traditional forms of lending.

‘While it is not appropriate for a number of industries, asset-based lending suits the manufacturing sector well,’ claimed Martin. ‘Manufacturing is an asset-intensive process and firms havethe ability to raise finance against stock, capital equipment and property and production facilities.’

There is often confusion between asset financing and refinancing, but according to Russell Warner, commercial director at Eurofactor, they are really very similar.

‘The fundamental difference is that with re-financing you will have an existing asset based lending line (ABL) in place. Therefore, for many reasons you may be looking to switch either providers or the nature of the funding; but in other respects they are exactly the same.’

An asset-based lending plan will allow firms to convert balance sheet assets into operating cash, utilising a variety of tools. Typically these are commercial mortgages against property; debt finance, stock financing against balance sheet inventory; and borrowing against unencumbered plant or machinery.

There is also the difficult area of IP, which is not so tangible, but there are specialists that will take a view of this.

‘If you combine the whole package, that is really your asset-based lending proportions. How much you need and how you leverage depends on the business requirements and the availability within those larger assets,’ said Warner.

It is only in the past five years that the UK has started to pick up on asset financing, partly because of an economy that is not growing rapidly enough to meet borrowing requirements through traditional avenues.

‘The use of asset financing has been growing and that is in direct contrast to overdrafts,’ said Warner. ‘They have been declining because they are nonspecific, repayable on demand and the cashflow lends that have been provided are very much driven by covenants provided by the financial institutions putting forward the money.’

The dilemma here is that instead of being linked to a businesses’ lending requirements, overdrafts are controlled by these covenants, or secondary targets.

The main form of asset lending that small or medium-sized businesses would make use of is factoring or invoice discounting, where cash is advanced on a regular basis against book debts; and that is a composite part of an asset-based lending package. ‘There will be a proportional link to commercial mortgages or to machinery parts, and an element linked to stock. But usually the key driver to the whole process will be the underlying receivable facility, either in the form of factoring or invoice discounting,’ said Warner.

There are of course pitfalls, but according to Graham Plater, of Bibby Finance, these are minimal. ‘A borrower re-financing needs to make sure he’s selling the assets for a price which is equal to, or greater than, its book value; and that the cash he generates is reinvested in the business,’ said Plater.

As with all financial decisions it is prudent to seek expert advice, and from more than one source. The first port of call should be your bank, but also try an independent lender or a financial consultant.