29 Apr 2024
Why asset-based lending is on the rise
In today’s high-interest-rate environment, private-equity (PE) partnerships are facing tighter terms, lower leverage and a higher cost of servicing debt. But in these adverse conditions, general partners (GPs) are taking an increasingly creative approach to financing structures.
Our Private Equity Trends 2024 report confirms that a large proportion of GPs are using asset-based lending (ABL) as an alternative source of financing. Our survey shows that almost half (48%) now see ABL as their second or third choice.
For most GPs, senior bank debt is the staple, with a full 54% of our survey respondents using it as their first choice. Meanwhile, just 5% use ABL as their first resort. That’s either due to its lack of relevance to asset-light borrowers (with limited receivables, inventories or fixed assets as a borrowing base) or due to the fact that ABL on its own often doesn’t achieve sufficiently high quantum of lending to gain relevance in mainstream M&A deals.
However, the increase in the use of ABL as an alternative is notable, nonetheless. So, what’s behind its growing uptake?
Focus on cutting costs
The most obvious answer is cost. At present, pricing and cost management are more important than ever. With interest rates elevated, every percentage point that can be shaved off margins is a major plus. Because of the greater security it provides to lenders, ABL can offer lower-cost finance and potentially greater leverage to companies with the requisite assets, particularly if it can be combined with cashflow lending. In uncertain times, that can be a deeply attractive prospect.
Flexibility amid fluctuations
Another advantage of ABL is the greater flexibility that it offers to both lender and borrower. In traditional cashflow-based lending, fluctuating working capital can significantly impair a company’s access to finance. By contrast, the solid anchoring of an ABL facility means that the borrower can operate with greater confidence as working capital swings are accommodated.
This is a particular advantage in volatile times – as today, when the economic environment is unpredictable, supply chains are under pressure and inflation is eroding the value of cashflows.
Cash is king
The greater appetite for ABL also reflects a sharper focus on maximising cash generation. Essentially, ABL allows an asset-rich borrower to monetise those assets, and its flexibility allows companies to free up working capital to boost their operations and fund their growth. ABL revolvers can also contribute acquisition finance firepower.
Typically, an ABL revolver is larger than a revolving credit facility (RCF) – because the former is secured against an asset base, giving the lender greater comfort. And while an RCF usually has to ‘clean down’ to zero at certain points of the year, ABL can be lent perpetually, as the assets are always being monitored as part of the lending process.
Understanding assets
That level of monitoring holds attraction in its own right. Many sponsors value the discipline that comes with operating an ABL facility. Because of the scrutiny applied to the collateral, GPs can benefit from improved reporting and a better understanding of their assets.
An integrated approach – and a role in acquisitions
Crucially, ABL doesn’t have to be a standalone arrangement. It can be combined with traditional cash flow-based lending in a single structure. This integrated approach can have significant advantages. In particular, both borrower and lender can benefit from a single banking relationship – avoiding the many problems that can arise when a lending structure involves a mix of creditors. Essentially, the borrower benefits from a stable relationship and reliable cash flows while the lender benefits from greater oversight and security.
Besides addressing working capital needs, a combined ABL/cashflow structure can be used for acquisition finance – an aspect of ABL that is perhaps less well understood than it ought to be. As with any ABL arrangement, much depends on the nature of the businesses in question. However, for companies with substantial assets, a blended ABL/cashflow approach can be an excellent cost-effective option.
Investec’s edge in Integrated ABL/cashflow
At Investec, we’ve been offering integrated ABL/cashflow lending structures since 2007. Our business has been built as a specialist offering with a focus on private equity, so we have an in-depth understanding of sponsors’ requirements – whether those are acquisitions, refinancing, recapitalisation or simply growth. For the right businesses, our blended approach offers a cheaper cost of capital than mainstream senior debt and potentially higher leverage.
With economic conditions uncertain, inflation still high and interest rates yet to fall, ABL can provide GPs with a potent combination of flexibility and firepower. In that respect, ABL’s growing prominence as an alternative is no surprise – and we expect to see this trend continue in the years ahead.