Asset-Based Loans: How Growing Companies Can Leverage Their Assets for Financing

In the mid-market, capital strategy is about using every tool in the toolbox to your advantage.  CEOs and CFOs often face a familiar dilemma: growth outpaces liquidity, but cash-flow-based credit options lag behind. Asset-based lending (ABL) sits quietly in the middle: a flexible, data-driven structure that transforms a company’s balance sheet into a revolving source of liquidity. Used correctly, it’s not just a funding mechanism; it’s an operating strategy that can enhance valuation multiples, accelerate growth, and preserve control.

The Strategic and Operational Landscape of Asset-Based Loans (ABL)

Core Mechanics: ABL Structure and Primary Repayment Source

Asset-Based Lending / Loans / Lines (ABL) is a specialized form of secured financing where the lender advances funds based directly on the liquidation value of a borrower's specific assets, known as collateral. Unlike traditional commercial loans that rely primarily on future cash flow stability (measured by metrics like EBITDA), ABL zeroes in on the current quality and convertibility of balance sheet assets.

ABL facilities are typically structured as revolving credit lines (revolvers), allowing a company to draw, repay, and redraw funds continuously, up to a limit defined by the Borrowing Base (BB). The primary assets used as collateral are accounts receivable (AR) and inventory, although equipment, real estate, and occasionally intangible assets like IP can also be included.

The critical factor is that the primary source of repayment for the revolving portion is the ongoing conversion of the collateral (collecting AR and selling inventory) back into cash over the company’s normal operating cycle. This continuous monitoring and cash management process is central to the ABL structure.

Strategic Value Proposition of ABL

ABL is a compelling financing tool for companies that possess substantial liquid assets but may exhibit characteristics less favorable to traditional cash-flow lenders, such as rapid growth, seasonal fluctuations, inconsistent earnings, or high leverage.

Because the credit determination hinges primarily on the appraised liquidation value of the assets, ABL allows a company to access significant financing where cash flow lending may be highly restricted.

A key benefit often cited for ABL is its covenant-light structure. While traditional loans impose strict maintenance covenants (e.g., Debt/EBITDA, FCCR), ABL facilities typically replace these numerous financial tests with a primary liquidity covenant and operational controls. This flexibility grants the corporate borrower greater latitude in making strategic decisions without immediately risking a covenant breach due to a temporary dip in earnings.

Operational Considerations

While ABL offers flexibility, corporate borrowers must be aware of inherent operational burdens.

• Rigorous Due Diligence: Borrowers must pay for field examinations (known as collateral audits) and third-party appraisals of inventory, machinery, and equipment, anywhere from 1–4 times a year.

  
  

• Administrative Cost: This frequency of monitoring imposes an additional administrative cost on the company. In addition, most ABL facilities apply an unused line fee.

  
  

• Borrowing Base Certificate (BBC): The weekly or monthly preparation of the BBC requires time from the CFO’s treasury and accounting staff.

Accounts Receivable (AR) Collateral: Managing Eligibility and Dilution Risk

Defining and Identifying Eligible AR

The value of the accounts receivable collateral is determined by its eligibility—the likelihood of its conversion to cash.

Age is Key: The most common standard for eligibility is the age of the recipient. ABL facilities typically consider only current receivables as eligible collateral, generally defined as those that are less than 90 days from the invoice date or no more than 60 days past due.  However, with the right handling, lenders have been known to extend credit on AR that has aged up to 150 days (ask us how).

Ineligible Categories: Receivables are excluded from the borrowing base if they are deemed too risky, difficult to collect, or uncertain in value. Common ineligible categories include:

• Aged receivables (past the contractual limit).

• "Special Accommodations" exist under certain circumstances.

• Receivables subject to customer disputes or potential set-offs.

• Foreign receivables, unless covered by specialized credit insurance.

• Receivables due from related parties.

Strategy for Long-Dated Receivables (DSO > 90 Days)

The core structure of ABL mandates that accounts exceeding the contractual age limit (typically 90 days) are automatically deemed ineligible, reducing the available borrowing base.

• Factoring: Factoring (or receivables finance) involves the sale of the asset to a factor (the financier), providing immediate cash based primarily on the customer’s creditworthiness rather than the borrower’s policies or age profile.

  
  

• Credit Insurance as a Lever: A strategic tool that can influence a lender’s eligibility criteria is the use of credit insurance. If long-dated or foreign receivables are covered by a strong credit insurance policy, the borrower may negotiate to include these otherwise ineligible accounts within the eligible borrowing base. This transfers the default risk away from the ABL lender.

  
  

Customer Concentration and Borrowing Availability

Customer concentration exists when a high percentage of receivables originates from a small number of customers. This heightens the risk profile because the failure of one or two large accounts can disproportionately impair the value of the entire AR collateral pool.

ABL lenders mitigate this exposure by imposing a concentration reserve or a haircut on any portion of an account that exceeds a negotiated threshold (e.g., 20% of the total eligible AR pool). The portion exceeding this limit is deducted from the eligible AR base before applying the advance rate.

Deep Dive into Dilution, Chargebacks, and Accounts Payable Offset

Three key terms define specific risks within the AR collateral pool:

Term	Definition and Impact
Dilution	The reduction in gross accounts receivable due to non-cash credits (e.g., sales returns, allowances, freight charges). Lenders apply a dilution reserve (often based on a trailing 90-day rate) to anticipate this reduction. A sudden rise can signal fundamental operational issues.
Chargebacks	Specific customer claims or disputes that result in the customer deducting an amount from their payment. These amounts are reserved against, or completely excluded from, the Borrowing Base until resolved.
Accounts Payable Offset (Contra-Accounts)	Occurs when the borrower has an AR from a customer while simultaneously owing an AP to that same customer. The customer has a legal right of set-off. The ABL lender imposes a specific reserve against the AR pool equal to the corresponding AP owed to eliminate this exposure.

Mathematical Example: Impact of Dilution and Reserves on AR Advance

The following example illustrates how an ABL lender moves from the Gross AR balance to the final Net Borrowing Availability by applying eligibility, advance rates, and key reserves.

Line Item	Calculation / Value	Impact ($)
Gross Accounts Receivable Balance	N/A	$12,000,000
Less: Ineligible AR (Aged, Related-Party)	N/A	$(2,000,000)
Eligible AR Base	N/A	$10,000,000
AR Advance Rate	80%	N/A
Gross Borrowing Value (Before Reserves)	$10,000,000 x 80%	$8,000,000
Less: Dilution Reserve (Based on 6% historical rate)	$12,000,000 x 6%	$(720,000)
Less: Concentration Reserve (Amount over concentration limit)	N/A	$(300,000)
Net AR Borrowing Availability		$6,980,000

The Borrowing Base Calculation: Mechanics of Liquidity Access

The Formula Structure: Advance Rates, Ineligibles, and Reserves

The borrowing base is the foundational formula used to determine the maximum funds a borrower can access at any given time. The calculation involves applying a negotiated advance rate (a percentage) to the value of the eligible collateral pool, then deducting specific reserves or blocks.

Advance Rates: These are highly negotiated and depend on the quality and liquidity of the asset. AR rates typically range from 65% to 90%, while inventory rates are substantially lower, typically ranging from 20% to 65%.

Role of Valuation Standards

For non-AR assets like inventory and equipment, ABL lenders use highly conservative valuation methodologies to protect against liquidation losses. The standard measure is the Net Orderly Liquidation Value (NOLV).

NOLV: This value represents the estimated proceeds that could be achieved from selling the assets in an orderly disposition, minus all associated costs of selling and marketing. Using NOLV establishes a sufficient margin to protect the lender against price risk during a necessary liquidation scenario.

Summarizing the Calculation: From Advance Rate to Net Borrowing Availability

The final goal is the Net Borrowing Availability, which is the critical measure for the CFO, representing the amount of borrowings that can be drawn at any one time.

1. Determine Gross Borrowing Value: Sum the contributions of each collateral category (Eligible Asset x Advance Rate).

   
   

2. Calculate Borrowing Base: Subtract all specific reserves (dilution, concentration, obsolete inventory, etc.) from the Gross Borrowing Value.

   
   

3. Determine Net Borrowing Availability: This is the lower of the Borrowing Base less any excess liquidity requirement or the Total Loan Commitment. Any outstanding balances would reduce this number.

The liquidity covenant is crucial, establishing a minimum dollar amount or percentage of availability that must be maintained at all times. Borrowing is explicitly prohibited if available funds fall below this threshold.

Table 1: Example Calculation of Net Borrowing Availability

Collateral Type	Eligible Value / NOLV ($)	Advance Rate (%)	Gross Borrowing Value ($)	Reserves Applied ($)	Net Borrowing Value ($)
Accounts Receivable (AR)	$10,000,000	85%	$8,500,000	$(1,100,000) from dilution and concentration	$7,400,000
Plus: Inventory (Finished Goods)	$5,000,000	50%	$2,500,000	$(500,000) from obsolescence	$2,000,000
Plus: Equipment (NOLV)	$4,000,000	50%	$2,000,000	$(0)	$2,000,000
= Borrowing Base (BB)					$11,400,000
Less: Excess Liquidity Requirement (5% of $20M Commitment)					$(1,000,000)
= Net Borrowing Availability					$10,400,000

Inventory Collateral: Stage Risk, Valuation, and Financing Unproduced Goods

Inventory Eligibility and Ineligibility

For inventory to be included, it must pass a strict liquidity test: it must be readily salable. The field audit and appraisal will exclude inventory that presents excessive liquidation risk.

Key Exclusions: Obsolete, slow-moving, or perishable goods; highly specialized or customized inventory manufactured to a single customer's specifications; and inventory located at unmonitored or third-party storage facilities.

Advance Rates and Liquidation Value by Stage

Inventory advance rates are highly dependent on the current state and fungibility, generally ranging from 20% to 65%. The determination is based on the liquidation value (NOLV) and the ease of resale.

Inventory Stage	Typical Advance Rate (NOLV)	Rationale
Finished Goods (FG)	50%–65%	Highest rates. Ready for immediate sale and conversion into AR / cash.
Raw Materials (RM)	20%–50%	Moderate rates. Commodity raw materials (e.g., steel) are highly liquid. Specialty materials may have nominal resale value.
Work-in-Process (WIP)	0% (Frequently excluded)	Lowest rates. Rarely included because it requires substantial additional production cost (labour, overhead) to become saleable.

Financing Pre-Production Needs and Unproduced Inventory

If the inventory has not yet been produced, it cannot be collateralized under a traditional ABL facility, which requires physical, existing stock. This requires specialized trade finance solutions:

• Purchase Order (PO) Financing: Designed to bridge the gap when a company has a confirmed sales order but lacks the capital to pay the supplier. The financing is based on the value of the PO itself.

  
  

• Specialized Work-in-Process (WIP) Financing: Used for companies with long production cycles. It's a line of credit secured against the value of partially completed goods, providing capital to cover ongoing costs like labor and overhead until the final product is delivered.

  
  

• Merchant Cash Advance (MCA): a form of financing where a business receives an upfront lump-sum in exchange for a percentage of future revenues. Instead of traditional loan payments, the funder collects automatic withdrawals daily or weekly. They are not calculated off or secured by AR, inventory, or equipment.

Equipment Financing: Eligibility and Valuation Methodologies

Equipment Eligibility Criteria

Equipment financing within an ABL structure is used for general machinery and equipment (M&E) that can act as secondary collateral. The lender’s primary concern is marketability—the ability to monetize the asset quickly in a secondary market.

• Eligible Equipment: Standard, general-purpose machinery that maintains a broad appeal.

  
  

• Ineligible Equipment: Highly specialized or single-purpose assets (e.g., customized tooling) that are difficult to liquidate to a broad pool of potential buyers.

  
  

Valuation and Advance Rates

The value is assessed using conservative methodologies by a third-party appraisal firm.

• Valuation Method: The standard is the Net Orderly Liquidation Value (NOLV).

• Advance Rates: Usually the lowest of all ABL collateral categories, generally capped at 50% or less of the NOLV. This reflects the illiquid nature of M&E, accounting for the extended time horizon and higher disposal costs required for liquidation.

Comparative Structures and Covenant Analysis

Differentiating Financing Products

Understanding the legal and structural differences between ABL and other working capital solutions, particularly the distinction between a secured loan and an asset sale, is vital

Table 2: Comparison of Working Capital Financing Structures

Feature	Asset-Based Loan (ABL)	Inventory Financing (ABL Sublimit)	Factoring / Invoice Financing	Purchase Order (PO) Financing)
Underlying Transaction	Secured Loan	Secured Loan	Sale of Future Receivables	Loan / Advance Secured by Confirmed Order
Collateral Focus	Pool of Eligible AR, Inventory, Equipment	Existing, Finished Goods Inventory	Specific, Billed Invoices	Confirmed Purchase Order (Future Inventory)
Title to Assets	Borrower retains asset title	Borrower retains asset title	Title of invoice transferred	Borrower has not taken title to product
Customer Notification	Confidential	Confidential	Required: Payment directed to Factor	Required: Payment directed to Financier
Risk Focus	Collateral Liquidity and Borrower Solvency	Liquidation Value (NOLV) of Stock	Customer Creditworthiness(Non-recourse)	Supplier / Fulfillment Risk
Primary Goal	Maximize balance sheet leverage and working capital	Purchase stock for general future sales	Accelerated cash flow from slow-paying customers	Fund supplier production costs (Pre-Inventory)

The Mechanics of Factoring vs. ABL

• Factoring: Legally defined as the outright sale of accounts receivable. The factor purchases specific invoices at a discount (receiving 70%–90% immediately). For the CFO, the asset is removed from the balance sheet, carrying different accounting and legal implications than a loan.

  
  

• ABL Using Borrowing Base: The ABL facility is a revolving loan secured by collateral that the borrower retains. The BB mechanism requires the borrower to report all new sales and collections weekly or monthly via a Borrowing Base Certificate (BBC), which recalculates the available loan balance against the current value of the collateral pool.

Typical Covenants Associated with an ABL Facility

ABL is generally considered "covenant-light" because it relies more heavily on operational and collateral controls than traditional financial maintenance ratios.

• Financial Covenants: These are usually springing, meaning they only become effective if the borrower breaches a defined liquidity trigger.

  
  

• Negative Covenants: Standard restrictions on the borrower’s ability to take actions that could reduce the value of the collateral or impair the lender’s position.

Conclusions and Recommendations

Asset-Based Lending provides a powerful, asset-driven solution that can significantly increase borrowing capacity, particularly for businesses with substantial balance sheet assets and fluctuating earnings.

• Covenant-Light Advantage: The corporate borrower benefits from the ABL’s covenant-light structure, trading the complexity of cash-flow covenants for tighter operational control by the lender.

  
  

• The Trade-Off: The perceived flexibility must be weighed against the operational constraints imposed by field examinations, administrative costs, and the adherence to cash dominion protocols.

  
  

• Strategic AR Management: The CFO must anticipate that long-dated accounts receivable (over 90 days) will be ineligible, necessitating alternative financing strategies like factoring or securing credit insurance to monetize these otherwise excluded assets.

For the corporate borrower, the successful management of an ABL facility hinges on precise collateral management and diligent reporting.

Frequently Asked Questions (FAQs)

ABL Mechanics & Structure

What is the core difference between ABL and a traditional cash-flow loan? 

ABL primarily assesses and relies on the current liquidation value of a company’s assets (collateral), while a traditional loan primarily assesses and relies on the company’s future cash flow stability (EBITDA).

What are the primary assets used as collateral? 

Accounts Receivable (AR) and inventory. Equipment and real estate can also be included.

What is the Borrowing Base (BB)? 

It is the foundational formula used to determine the maximum funds a borrower can access at any given time. It is calculated by applying an advance rate to eligible collateral and then deducting specific reserves.

How often are borrowing bases updated? 

Most lenders require weekly or monthly certificates (BBCs).

Does my company have to be profitable to obtain an ABL? 

No, even unprofitable companies can be eligible.

What makes accounts receivable ineligible? 

Receivables that are deemed too risky, difficult to collect, or uncertain in value. Common examples are those aged past the contractual limit (typically 90 days), those subject to customer disputes, or those due from related parties.

What is a dilution reserve? 

It is a reserve applied by the lender to anticipate the reduction in gross accounts receivable due to non-cash credits such as sales returns, allowances, and freight charges.

What is NOLV and why is it used? 

Net Orderly Liquidation Value (NOLV) is the standard valuation measure for non-AR assets like inventory and equipment. It represents the estimated proceeds from selling the assets in an orderly disposition, minus all associated costs, establishing a conservative margin of safety for the lender.

Why is Work-in-Process (WIP) inventory often excluded? 

WIP is rarely included in the Borrowing Base because it requires substantial additional production cost (labor, overhead) to become saleable, presenting an unacceptably high risk to the lender's liquidation recovery.

What is the "covenant-light" structure? 

A key benefit of ABL. ABL facilities typically replace strict financial maintenance ratios with a primary liquidity covenant and operational controls. This gives the borrower more operational flexibility.

How does ABL offer liquidity without dilution? 

ABL allows companies to borrow against hard-earned assets at a cost typically much lower than the implied cost of issuing equity.