Sponsor-backed companies often require flexible, cost-effective funding to finance growth, acquisitions, or general working capital. Our experience over the last 18 months has seen an uptick in the use of asset based lending (ABL) as a malleable, competitively priced, scalable financing option.

This change has several key features:

• more sophisticated market entrants including clearing banks, challenger banks and alternative lenders entering the market and providing increased ABL debt appetite. We have seen ABL funders building specific sponsor teams to access this area of the market;
• more complex syndicated structures becoming more common place to cater for the demand of larger debt sizes; and
• the LMA’s support to provide a standard market position with the introduction of the borrowing base facility agreement last year. This is a big step forward as it is a format of document sponsors are much more familiar with and shows a deviation from traditional very restrictive lender standard form documentation to cater for the more complex financing arrangements involved in the sponsor arena.

ABL facilities are secured structures allowing companies to leverage their assets such as receivables, inventory, or equipment – the value of which dictates the facility size known as the ‘borrowing base’. Due to the type of assets being secured, the borrowing base may fluctuate based upon the asset value which can be particularly attractive for seasonal businesses. The borrowing base allows the ABL facility to grow with the company as the borrowing capacity is directly linked to its value – subject to any total commitment caps. This scalability has proven attractive within the sponsor-backed space.  Particularly as the aim of sponsor based groups is to grow, whether by improving trading or via acquisitions.

Practical points for private equity-backed companies considering ABL financing are:

• Financial hygiene: ABL facilities force businesses to have good financial hygiene. Due to the frequent re-calculation of the borrowing base, borrowers have more reporting requirements to determine the availability of facility and extent of the lender’s security. Lenders also often have more sophisticated accounting systems which Borrowers use to report the fluctuation in the value of their various assets which means sponsors can benefit from this improved reporting.
• Price: ABL facilities’ pricing is a blend of interest and fees for asset appraisal and maintenance. Due to the fixed security granted, ABL financing offers competitive interest rates which even with any ongoing fees often offers a pricing differential to other types of financings making them proportionally cheaper.  ABL Facilities supported by fixed security have a lower capital requirement for funders also contributing to this price differential.
• Timing: this is not a type of financing that can be used to fund the initial investment or acquisition of a company by the sponsor due to the due diligence requirement of lenders in relation to the target business. We have, however, seen private equity firms bridging the cost of the acquisition and refinancing the investment afterwards. This can take time but offers an excellent route for private equity funds to unlock capital post-acquisition and in the current market where debt returns are high is attractive to sponsors as they can generate a return on their initial investment that is often not a million miles away from their funds target return. This ability to offer an ‘equity bridge’ will be dependent on the ability of the relevant sponsor to receive repayment of funds and to then reinvest them.

ABL is no longer a plan b for businesses with liquidity requirements and where more traditional loans are not an option. Instead, ABL is becoming a funding option of choice; increasingly so in the sponsor backed market.