Any chief financial officer in the US will be familiar with asset-based finance (ABF). This type of arrangement is used extensively in US business, from small companies to the largest corporations. Indeed, total credit line commitments by US asset-based financiers amounted to $176.5bn (£113.6bn) in 2011, according to the Commercial Finance Association.
Among UK companies, ABF has tended to keep a much lower profile, often seen as the exclusive preserve of smaller companies and entrepreneurs, or even something of a last resort.
Yet the signs are that the pressures created by the recession – and by the banks’ clampdown on traditional business loans and overdrafts – are forcing British companies of all sizes to rethink their attitude to ABF products such as invoice discounting and asset-based lending.
Kate Sharp, chief executive of the Asset Based Finance Association, says: “In the UK, this market has traditionally been an alternative market. Businesses think loan first, overdraft second and ABF something like fifth or sixth. But the fact is that ABF can work for small companies with a very small turnover and it can also work for corporations with a turnover of £400m-£500m.”
Ms Sharp says banks’ increasing emphasis on risk analysis, especially in the light of the Basel III capital adequacy regulations, could also be prompting them to look again at ABF. “Banks are becoming far more aware of where they lose money, and invoice lending and asset-based products are now recognised as being much less risky for the financier,” she says.
“If you look at the way the markets work in the US, they are totally risk-focused. And right there at the top, the first type of low-risk, senior secured debt you will be offered is asset-based finance.”
Of the approximately 4.5m businesses in the UK, only about 1 per cent currently use asset-based finance, says Ian Larkin, managing director of Lloyds TSB commercial finance. But he adds: “We reckon 10-15 per cent of businesses could use it.
“These forms of finance don’t work for everybody. But if you are a business-to-business company – a wholesaler or a supplier – and you get paid in 90 days, you can use this arrangement to get some of the money upfront.
“This is a growing area,” says Mr Larkin. “Firstly, for companies that are looking for more ways to release working capital. And then in the larger, more corporate space, finance directors are looking to make more leverage out of their balance sheet.”
About 50 per cent of the businesses to whom Lloyds offers ABF are corporates, he says.
One company that has used ABF to help fund rapid growth is Eco Plastics, a Lincolnshire-based recycling group. Its plant sorts and reprocesses plastic – more than 200 tonnes a day – to create rPET (recycled polyethylene terephthalate) for use in making food packaging.
In 2011, Eco Plastics sealed a joint venture with Coca-Cola, the drinks group, that will be worth £250m over the next 10 years, says Jeff Holder, chief financial officer. The company opted for an asset-based lending deal with Close Brothers, the investment bank.
Under this form of ABF, a company borrows money using its assets, such as plant and machinery, as collateral.
“We will have achieved growth of up to about 600 per cent between 2008 and 2012,” Mr Holder says. “Our kind of business is obviously asset-rich, and our deal with Close Brothers has enabled us to asset-finance both the equipment and the working capital that we needed to put in place.”
He says the company considered loans and overdrafts but those were “not able to factor in the growth that we needed. The asset-based lending approach put together by Close Brothers allowed us to build in growth,” he says. “The banks were just not as creative and flexible.”
Another popular form of ABF is invoice discounting, where a business can borrow against its order book. Such arrangements are distinct from factoring, in which a company effectively hands over its order book to a third party, or factor, in return for cash.
Mr Larkin at Lloyds says: “The asset-based finance market in the UK started with factoring about 40 years ago. The big difference between factoring and invoice discounting is that with factoring, our client’s debtors pay us, so they know that our client is using factoring as a form of finance. Invoice discounting is an arrangement between us and our customer, behind the scenes.
“The motivation for businesses has been that they would rather not have the disclosure to their clients about what kind of finance they are using, which is why over the past 20 or 30 years the market has shifted away from factoring towards invoice discounting.”
An invoice discounting deal can allow a company to receive up 90 per cent of the value of its unpaid invoices, says Nick Dodd, a director in debt advisory services at KPMG, the consultancy, but the finance company will scrutinise the company’s receivables closely. “Old invoices probably won’t qualify, and they might not be happy if the bulk of the money comes from just one or two customers,” he says.
Nevertheless, Mr Dodd says ABF can be very flexible compared with traditional loans. “In the UK, ABF has perhaps been often unfairly associated with smaller, low-quality deals,” he says. “It does not deserve that reputation, and it’s very different to the US where it is an absolute cornerstone of corporate America.”
Ms Sharp at the Asset Based Finance Association says: “About 20,000 really small businesses in the UK use factoring. But there are 272 clients with turnover of more than £100m. Asset-based finance really can move through the ranges and can be suitable.”
While the average ABF advance in the UK is still only £350,000, that figure is significantly higher than the £250,000 in 2005, Ms Sharp says. The average turnover of companies using ABF has also risen from £3m to £5m in that period, she points out.
“There is obviously still a long way to go before it reaches the kind of level in the US. Businesses need to be re-educated, and that will take some time. But misconceptions and prejudices are changing.”