A helping hand – asset-based finance

The Americans are coming! Factoring and invoice discounting may have ruled the roost in the UK for the past few years, but the influx of several US providers offering a far more flexible stock-based finance lending is about to change things. Asset-based finance is the most commonly used term for the service, although ?sales? or ?invoice? finance are frequently used for the latest thing in corporate lending.

Whereas factoring was the ideal means for smaller companies to finance working capital needs, the new product offers all kinds of operations greater flexibility. In the last ten years, factoring has doubled in the US ? asset-based finance has grown fivefold. The US raiders, Bank of America, Bank of New York, GE Capital, Congress Financial and Transamerica Commercial Finance will attempt to recreate the same sort of success in the UK. They join up-and-coming UK suppliers, including Burdale and NMB-Heller.

The new players bring the financial muscle to support UK or even pan-European deals for companies with turnovers ranging from #1m to #200m. Where they differ from invoice discounting companies is that these companies offer finance against the stock held by a company. The level and extent of the lending can differ from securitisation against plant, machinery and property, as well as licenses and intellectual property. Close Invoice Finance, a factoring company owned by US merchant bank Close Brothers, has added a wider set of services to its factoring business. Managing director Leslie Bland says: ?We?re buying goods on behalf of the client that will ultimately own them.?

Bank of America was one of the first to address the UK market when it established a commercial finance unit in London in May 1997. Paul Hancock, senior vice-president of its UK commercial finance unit, says a company?s assets and its plans for the future ? rather than its history ? are determinants for borrowing power. ?We start with the most attractive asset, the invoices which are the most liquid. Then we move on to the stock, plant and machinery,? he says.

It is a more flexible approach to financial support that offers more than the standard ways of financing working capital. Bank overdrafts, invoice finance, leasing, term loans, stock finance or letters of credit were traditionally obtained from different sources. One supplier leased the plant and machinery while another financed the book debts ? with the bank normally providing an overdraft, loans and letters of credit. According to John Bagley at NMB Heller, growing businesses are now able to source all their working capital from under one roof.

Asset-based finance is also the ideal vehicle for funding MBOs and MBIs because of the possibility of offering a structured solution. According to Bagley, options include using invoice finance as well as a term loan, while plant and equipment leasing is provided by NMB Heller?s associated company ING Lease. ?In this way, those purchasing the company can avoid relinquishing equity in the business,? he says.

Another big difference between the old and new style of lending is that asset-based financing can target large companies. Hancock says: ?Most will be different ? concentrated on larger companies rather than the smaller. The average size of a factored company is #1m turnover.?

Its champions say asset-based finance can even be a real alternative to an overdraft and could make real inroads into the banking market which has seen loan business fall 40% in the last four years. ?It is recognised lending in a different way and requires a different approach by lenders,? says Dennis Levine, managing director of Burdale. ?I?m confident that it will gradually replace the overdraft and eventually become part of normal commercial lending.?

The beauty of this form of asset-based financing is that it will appeal to finance directors, who can predict the flow of assets more readily than cashflow. The impact is such that companies are less likely to fall foul if lending is linked to assets rather than future cashflow. It will provide an ideal solution in a period of volatile cashflow if they borrow against assets. ?It is also possible because management teams understand business dynamics better than before,? says Gary Edwards, managing director of GE Capital.

The type of companies most likely to benefit from this financing are those that operate along seasonal or unusual time-frames. It can involve turnarounds, restructuring, or any external event that drives the company?s trade. ?When there is a huge order requiring 50% increase of capacity of factory, how do you service that when you only have traditional numbers?? asks Dennis Levine, managing director of Burdale. ?If it is a good customer, we will finance it through the manufacturing process, whereas traditional bankers can?t do that,? he says.

Levine adds that Burdale is targeting the manufacturing sector because ?they traditionally have lots of assets that banks don?t like?, such as older plants and work in progress. ?The lending market is buoyant, so banks are only offering money in profitable areas. So we go to manufacturing, where there are turnaround situations,? he says.

Bank of America has concentrated in the UK on deals in excess of #5m, backing seven or eight deals since May ? ranging in size from #10m to #50m. ?We have undertaken contracts in excess of #75m,? says Hancock. ?We did the acquisition of Glynwed which sold its material services division at the end of May, where total purchase price was #100m. We provided a credit line of #50m.?

Hancock adds that asset-based lending can help where earnings might move up and down sharply because of commodity price changes. ?Selling 20 million tonnes one year could produce #8m and #5m the next year. So rather than look at the cashflow, it is better to look at the asset value in a cyclical business determined by scarcity or over supply.?

Credit where credit?s due

Burdale recently funded the expansion of Stead and Simpson, which bought another 70 stores from British Shoe Corporation to add to the 400 it had already. ?We put a #12.5m line of credit,? says Levine. ?We also financed a company in the Midlands called Europa Commercial Pressings ? a buyout from a plc called Concentrica ? where we financed #6m,? he explains.

For GE Capital, the market comprises companies that create between #1m and #200m in sales. That is the core of our client base,? says Edwards. ?I see the market expanding because it is not overprovided, but it is unlikely that the clearing banks will get involved. They will still concentrate on what they do best,? he says.

Most observers agree that asset-based financing is set to become an increasingly important tool when the predicted economic downturn arrives. There is even an argument that those companies that use asset-based finance will come out of any downturn in a more robust state. Edwards says: ?These are businesses that are trading well, and if they don?t use it they could fall victim unnecessarily. But if economic downturn does happen, asset-based finance ensures companies are healthier rather than more vulnerable,? he says.

The reasoning behind this is that asset-based lenders seek to give a much deeper level of understanding once they have backed the business. ?Nobody likes surprises, especially bankers. Faced with a gaping hole, they don?t know what to do,? says Hancock. ?Asset-based finance offers the chance to know what is going on month to month in a company. 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 looked after,? he adds.

Asset-based finance will expand rapidly because competition is growing. As firms find stiffer competition, they will find new ways to lend, and new ways to achieve a decent margin. An increased level of funding is also likely to lead to a greater level of client contact. That could well be in the greater extent of due diligence and ongoing monitoring. It could apply to the levels of appraisal on plant and machinery. All in all, it is a much more entrepreneurial way of going about lending.

The flexibility that asset-based financing offers can create problems if financiers lend greater amounts in a bid to beat one another. Graham Spooner, head of corporate finance at accountant Kidsons Impey, cites one example where a lender offered #1.25m on a turnover of #3.5m and another then offered a facility of #1.5m.

Spooner says the biggest danger for companies is if it is used for long-term financing rather than as a short-term solution. ?It has a role, but I would look at it very carefully and not rely on it,? he explains.

There is still a lot of misunderstanding about asset-based finance, because it is still in its infancy and because it evolved from factoring and invoice discounting. Factoring took 15 to 20 years to develop, but the signs are that asset-based finance won?t need anywhere near that length of time to develop. It is sure to become an alternative form of finance and possibly a whole new agenda for business.

Factoring companies’ view

Traditional factoring companies have eyed up the threat that asset-based finance poses to their market dominance, but most have refused to join in. The view appears to be: why veer away from what you do best when the market for orthodox factoring is expected to grow from 15% to 20% a year?

Many of the larger factoring companies owned by UK clearing banks are also reticent when it comes to entering the market because of the conflict it would create with existing loan facilities and leasing operations.

One of the largest players in factoring, Alex Lawrie, owned by Lloyds TSB, will maintain its strategy of increasing its share of the smaller company end of the field. Its concentration on SMEs, from start-ups to #10m turnover operations, has led to a 20% share of the #50bn market, worth 5% of national GDP.

Marketing director Paul Sanders says the asset-based financiers will have limited impact on Alex Lawrie?s business for the time being. He says: ?In the short term, the smaller end of the market is less attractive to big players because of the entry costs involved. But in the long term, pressure will come from European and US companies entering the market.?

In January, the Bank of New York bought International Factors from Lloyds TSB to form BNY International. Sanders believes the move offers new financing opportunities for Alex Lawrie with TSB?s banking network. ?We?re anticipating expansion of work to 1,600 new businesses a year,? he says.

Independent factoring companies are also confident they can survive the new era, despite the prevailing threat of the US companies. David Marsden, the chairman of independent lender RDM Factors, says: ?The type of business we deal in would not necessarily require asset-based lending because it is not always appropriate to borrow against the assets or balance sheet.?

Marsden explains that smaller independents in the factoring world are able to adopt an approach that may be more flexible than any bank-owned structure. He says smaller players are able to offer work at the ?more innovative end?. He adds: ?That is how we are able to hold on to market share.?But he admits that, inevitably, RDM will move in line with asset-based financing to stay competitive.

Independents are more likely to maintain a competitive edge in the smaller owner-managed businesses in the #250,000 to #2.5m turnover range. Many independent lenders see the effect of the US asset-based financiers pushing up the average lending bill. Nick Saunders, marketing director of Abbey National-owned First National Factors, says at least one US company is only interested where it can be paid at least #18,000 a year. He says: ?On a turnover of #500,000, it represents 3.6% ? which is a lot of money. In this sense, US entry hasn?t enhanced the OMB market at all.?

Sanders says First National Factors is set to expand its share of the OMB market by attracting between 130 and 200 new clients this year. It currently has 400 clients with combined turnover of #400m.

Case study: frith?s flexible packaging management buy-in

NMB Heller and ING Lease ? sister companies in the ING Group ? recently collaborated to finance David Watson?s management buy-in of packaging specialist, Frith?s Flexible Packaging in June. A combination of leasing, invoice finance and a term loan secured the deal speedily, without the purchaser relinquishing any equity to a third party.

Watson had held senior positions in packaging production management and wanted to develop his own group. He approached Horwath Corporate Finance to identify the best business to acquire and, crucially, source the funding.

Mark Aldridge, a partner at Horwath says: ?We worked with David Watson to identify an acquisition target which would be a good solid platform with potential for growth. We found the ideal purchase in Frith?s.?

Established more than a hundred years ago as a supplier of nuts and dried fruits to the confectionery industry, Frith?s Flexible Packaging has 35 employees and turns over around #4m a year.

Aldridge says invoice finance had been arranged for the book debts, but a leasing operation was required to finance a higher percentage of the plant and equipment. He says: ?It is unusual to find leasing companies that will fund beyond 75% for existing plant. We used a broker to introduce us to ING Lease, which was prepared to go to 100%. We then switched to NMB-Heller for working capital, because NMB and ING Lease could work together to produce a fast-track service. We had an ?agreement in principle? very quickly and completed the whole deal, from start to finish, within three months. The speed of the transaction was helped by the finance providers? lack of red tape.?

Once the source of finance had been agreed, David Watson appointed solicitor Lawrence Stephens to join the team to provide legal support. Jeff Rubenstein, a partner at Lawrence Stephens, found a situation where a partnership ethic stood out. ?It is still unusual to arrange acquisitions without involving venture capital. The close relationships we were able to develop made this a fast-moving and satisfying deal. Although I was officially acting for the purchaser, all parties worked together to iron out the details before legal documents were drawn up.

?Normally, the legal aspects of a sale will be wrangled over for sometime but, on this occasion, the work put in beforehand allowed a very short timescale. We worked closely with ING Lease and NMB Heller over ?due diligence? requirements and the final transfer of funds, which was effected smoothly, with no problems.?

David Watson was keen for the acquisition to be free of any third-party equity stake. ?With the combined skills of the accountancy, legal and finance teams, I achieved my goal with the minimum of frustration and delay,? he adds.

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