To witness an asset-based financier shift uncomfortably in his seat, all you have to do is suggest that his clients are what might be termed problem’ companies. He might counter that any problems’ need only be temporary and that the key to success is detailed due diligence to establish that the underlying story is a good one. Nonetheless, they are often businesses whose balance sheets are riddled with brackets.
And this is precisely why a gap has emerged in the UK market for the provision of debt finance traditional lenders, with their focus on balance sheet strength and future cash flows, are unlikely to go near such businesses. It is a gap being filled by a number of US institutions, keen to replicate the success of asset-based finance in their domestic market, where in the last ten years its provision has grown five-fold.
The argument is that lending does not have to be cash flow-based and does not have to rely on past performance. Asset-based finance lends against a variety of assets which may encompass stock, debtors, plant and equipment, and land and buildings in an attempt to match the assets of a business to its borrowing requirements. This is all on the assumption that the business is being run by a credible management team with the ability to improve the company’s fortunes.
In the UK, asset-based finance is a recent phenomenon, though growing fast. One of the first into the market was Bank of America, which set up a London team led by Paul Hancock in May 1997. The team has been involved in five deals this year, including a joint arrangement alongside Comerica Bank of GBP50 million of acquisition and working capital facilities for the acquisition of Glynwed metal services division from Glynwed. The business, a non-ferrous and stainless steel distributor, was suffering from a sharp downturn in an industry subject to cyclicality, and was unattractive to a cash flow lender. While the amount of stock shifted in such a business might remain relatively constant, the earnings will be significantly different depending on constantly fluctuating metal prices, meaning that a traditional lender will have difficulty in calculating an appropriate EBIT multiple.
Says Hancock: “Asset-based finance is ideal for this type of business as it moves directly in line with stock and debtors and ensures that funding is immediately available to take opportunities to build up stock or take orders in a fast-moving environment.”
There are a plethora of difficulties which lead to demand from companies for funding of this nature: market conditions, the company’s own capital structure, cyclicality, seasonality and the loss of a key customer are among them. The asset-based financier will need to be convinced that the management team is focused on the specifics of how he is going to get the business through the problem. Says Hancock: “In our view, a management team that does not have a good grasp of its business and the way its assets move and the impact on cash may not be the right management team to see a company through its difficulties.”
Responsibilities placed on management do not end with the booking of the loan, however. For the loan to be booked in the first place, the lender will have to be comfortable with the story. Even so, there is never any guarantee that the business will return to profit in the short term, and the facility will normally incorporate collateral covenants. While Hancock insists that Bank of America will try to go forward in support of (its) clients’, it is clear that in many cases the relationship between lender and borrower will involve an ongoing dialogue.
Such a close relationship between lender and borrower would be surprising if the asset-based financier were merely buying into the asset quality and looking at the loan from a pawnbroking-type perspective. Paul Beveridge, a director at GE Capital Commercial Finance, which specialises in MBOs, MBIs and fast-growth corporates, insists this is not the case. “Because we’ve invested a lot of time and money up front in the business, we don’t want to have a book that churns in terms of taking transactions on simply because we can understand and validate the security aspect, and have already identified an exit route. We make sure we buy into the story and the projected turn-around whole-heartedly.”
Adds managing director Gary Edwards: “We will not enter a transaction unless we believe there’s a positive outcome to the business. It may be that it has historic overhead that’s now redundant, is dragging the company down and needs restructuring but there must be potential.”
Another leading asset-based lender in the UK is Burdale Financial, 80 per cent-owned by First Union bank, the fifth-largest bank in the US. Like Bank of America, it is attempting to provide solutions until now only available to companies on the other side of the Atlantic. According to chairman Dennis Levine, the firm has received a huge number of enquiries in the wake of economic turmoil around the world which has created trading difficulties for companies at the same time as the traditional lenders have been prompted into a squeeze on credit.
One of these came from a company in the glass industry which, despite being run by a team described by Levine as really good professional managers’, has suffered major losses recently. The reasons why will be familiar enough to businesses throughout the UK at present: a large percentage of one division’s turnover, which was dependent on the south-east Asian market, disappeared almost overnight; a product which accounted for GBP5 million of sales in Germany suffered a complete loss of demand due to the strength of sterling; and an oversupply of merchandise in the UK resulted after the loss of an important customer.
Typically, the manufacturing sector which stands to benefit most from the use of asset-based finance due to the existence of a lot of assets that traditional lenders are not comfortable with, such as older plant and work in progress. However, Burdale has also demonstrated its willingness to fund businesses in the retail sector following its provision of a GBP12.5 million line of credit to fund expansion at Stead & Simpson, which recently bought 70 stores from British Shoe Corporation.
The key to asset based lending are the due diligence and on going monitoring processes. This technique enables the lender to be flexible in satisfying the clients ever changing needs as the indepth knowledge of the business is most useful to borrower and lender. “The moment we see an imbalance in stock we have to start talking to the client,” stresses Levine. Adds Hancock: “We monitor businesses, and our systems allow us to get a handle on a subject in a difficult environment. We’re there to look at businesses that are not well served by traditional UK cash flow approach to lending.”
One might assume that a drawback for companies thinking of using asset-based finance would be its cost, but this is not necessarily the case. Any comparison with rates charged by cash flow lenders is a little misleading, as they are attracted by different types of deals. However, with senior debt structures in the buyout market, for example, becoming increasingly stretched in recent years, there is little difference in the up-front rates.
Paul Hancock insists that Bank of America would be happy to do deals at 1.75 over LIBOR, a rate fairly typical in the senior debt market. “It’s not necessarily more expensive than traditional lending. In fact, where you have two or three asset-based lenders wanting to do the same deal, you may even find prices coming down to a level below that at which a cash flow lender would do the deal,” he adds. In addition, though, there will be a fee-based income for the time spent monitoring the collateral.
As far as Europe is concerned the German market is perceived to be the one with the greatest potential in terms of being the largest market and easiest one to operate in. However, regulatory differences make all continental European markets, including German, seem like a rather distant objective. “If you asked us to fund debators and stock and other assets in Germany, practically we could do it because we could use the same monitoring procedures, but the problem is that laws relating to security and insolvency are so different, “maintains Levine p
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