What is asset-based finance?
Asset-based financing is when companies use their cash flow-generating assets, such as hard assets (e.g., automobile or plane leases), loans, or contractual cash flows (think pharma IP or music royalties) as collateral in order to raise a debt facility.
Let's say your company owns a fleet of automobiles in Louisiana, and that it has leased out those automobiles to individuals for a few years. Things are going well, and now you'd like to expand your business by purchasing more automobiles and expanding to Texas.
At a high level, you can raise funds for this purchase in one of two ways: selling equity in your company or raising debt. Companies often eschew equity fundraising in order to avoid dilution and retain ownership. If they choose debt, their priority then becomes minimizing borrowing costs. When available, the asset-based financing option can lead to the cheapest form of credit. In this example, asset-based finance would involve your company pledging future lease payments on the (existing) automobile fleet as collateral for a line of credit.
It's difficult to overstate the scale and ubiquity of asset-based finance; KKR estimates that the private asset-based finance market is $4.5 trillion globally, and that it will more than double over the next five years.
How does asset-based finance work?
The two main players in an asset-based finance deal are the borrower and the capital provider (also called the lender).
The borrower is the party with the portfolio of income-generating assets, and can be a financial technology company, a property technology company, or, as noted above, any other company with a predictable receivables stream. Borrowers will also usually work with a law firm during their debt capital negotiations to negotiate term sheets and credit agreements.
The capital provider is usually a Private Credit investment firm.
An asset-based debt raise often takes months to diligence, negotiate, and execute (we'll cover the nuts and bolts of the capital raise process in a future post). During the capital raise process, debt investors will scrutinize everything from a borrower's overall financial health, to asset-level KPIs, to origination policies and procedures.
After the capital provider and borrower sign a credit agreement, the capital provider either: (1) acquires the borrower's portfolio of income-generating assets (e.g., the automobile leases in the example above) and the cashflows associated with it, or (2) invests in a platform (an SPV, for example) that owns the borrower's originations and associated payments.
In either case, the execution of the credit agreement only marks the beginning of the borrower-capital provider relationship. Over the lifetime of the credit facility, capital providers check in regularly with borrowers on covenant compliance, portfolio performance against KPIs, and other aspects of debt capital compliance.
How can software help borrowers and capital providers streamline asset-based finance?
Traditionally, every step of asset-based finance—from deal sourcing to execution to monitoring—has happened in email, Microsoft Word, and Microsoft Excel. These tools are great for tasks like fine-grained analysis of asset performance or redlining legal documentation, but they have a crucial weakness: they can neither centralize key portfolio information nor track compliance obligations in real time.
In looking for tools to help streamline asset-based finance, borrowers and capital providers should focus on offerings that centralize key sources of information, enable proactive monitoring of debt capital compliance, and automate routine asset-based finance workflows (e.g., covenant waiver or draw request submissions).
For borrowers, investing in debt capital management software is a way to ensure credit agreement compliance in the short term and create a data foundation for funding diversification (e.g., multi-credit facility management or forward flow arrangements) in the long term. For capital providers, central borrower management software can augment the capabilities of financial analysts and ensure that nothing slips through the cracks.
Want to learn more?
When businesses contemplate asset-based finance, they should also think about building up the internal expertise and technology necessary to make the most of a credit facility. Otherwise, they may find themselves falling behind on debt capital and covenant compliance, which may lead to reduced (or blocked) access to capital. If you're interested in learning more about software that can help you prepare for an asset-based debt raise, just request a demo of Finley here.