Asset-based lending (ABL) means lending against specific assets a company owns, most often its receivables (money customers owe it) and inventory, rather than against its cash flow. A cash flow lender asks, "How much can this company's EBITDA support?" An asset-based lender asks, "If this company stopped trading tomorrow, how much could we raise from these assets, and how quickly?"
ABL suits companies with lots of working capital and uneven earnings: distributors, manufacturers, retailers and seasonal businesses. For analysts, it's a different way of underwriting. For LP-side analysts and IR teams, it explains why an asset-based fund can report low losses while lending to companies a cash flow lender would turn down. And for fund accountants and administrators, the borrowing base is a number they may see reported every month.
Lending against assets, not cash flow
Most ABL facilities are revolvers: credit lines the borrower draws, repays and draws again (PC101 3.1). As a company sells goods, its receivables rise; as customers pay, the cash repays the revolver. The loan grows and shrinks with the business. Some ABL deals add a term loan secured on equipment or property, but the revolver against receivables and inventory is the core.
What the lender relies on:
| Cash flow loan | Asset-based loan | |
|---|---|---|
| Main repayment source | The company's future cash flow | Collecting receivables and selling inventory |
| How much can be borrowed | A multiple of EBITDA | A formula based on the value of eligible assets |
| Key covenant | Leverage (debt ÷ EBITDA) | Often a fixed charge coverage test that applies only when availability is low |
| Lender monitoring | Quarterly financials | Borrowing base reports, often monthly or weekly, plus field exams |
Because the lender can see and control the collateral, ABL tends to be senior secured and priced below a cash flow loan to a similar company. The trade-off is heavy monitoring.
Eligible collateral and advance rates
Not every asset counts. The loan agreement sets out eligibility criteria, which exclude assets the lender may not be able to turn into cash. Common exclusions for receivables include:
- invoices more than a set number of days past their date, often 90
- amounts owed by the borrower's affiliates
- receivables from customers outside approved countries
- amounts a customer could offset against money the borrower owes it (contra accounts)
- too much exposure to a single customer (a concentration limit)
Inventory has its own rules: slow-moving, obsolete, damaged or in-transit stock is often excluded, and so is work in progress, which is hard to sell.
The lender then lends a percentage of each type of eligible collateral, called the advance rate. The gap between the collateral value and the loan is the lender's cushion. Receivables usually get a higher advance rate than inventory, because receivables turn into cash on their own when customers pay. Inventory has to be sold first, often at a discount.
Inventory is usually valued at its net orderly liquidation value (NOLV): what an appraiser expects it would fetch in an orderly sale over a few months, after the costs of selling it. NOLV is often well below the inventory's book value.
Reserves
The lender can also deduct reserves from the borrowing base. Reserves cover claims that could rank ahead of the lender or eat into the collateral in a liquidation, such as:
- rent owed to landlords where inventory is stored, since a landlord may be able to block access
- certain taxes and payroll amounts that may take priority by law
- amounts owed to suppliers who may be able to reclaim goods recently delivered
Loan agreements commonly let the lender set reserves in its "reasonable credit judgment," which gives it room to tighten availability if conditions change. Borrowers negotiate hard over that discretion.
The borrowing base
Putting the pieces together:
Borrowing base = (eligible receivables × advance rate) + (eligible inventory at NOLV × advance rate) − reserves
The borrower reports the borrowing base in a borrowing base certificate, usually monthly and weekly for larger or riskier credits, listing its receivables, inventory and the resulting figure.
How much the company can actually draw is its availability:
Availability = the lesser of the commitment and the borrowing base, less the amount drawn
The commitment is the maximum the lender has agreed to lend. The borrowing base can be higher or lower than that. Whichever is lower sets the ceiling.
A worked example: Marrowgate Foods
The following example is illustrative. Marrowgate Foods, a fictional food distributor, has an ABL revolver from Hollin Bay Capital's asset-based fund. The advance rates are illustrative; real rates depend on the assets and the lender.
| Step | Amount |
|---|---|
| Total receivables | $40.0m |
| Less ineligible receivables | ($8.0m) |
| Eligible receivables | $32.0m |
| × 85% advance rate | $27.2m |
| Eligible inventory at NOLV | $20.0m |
| × 80% advance rate | $16.0m |
| Less reserves | ($2.2m) |
| Borrowing base | $41.0m |
Now availability:
| Amount | |
|---|---|
| Commitment | $40.0m |
| Borrowing base | $41.0m |
| Lesser of the two | $40.0m |
| Less amount drawn | ($28.0m) |
| Availability | $12.0m |
The borrowing base of $41.0m is above the $40m commitment, so the commitment caps availability. Marrowgate can draw another $12.0m, not $13.0m.
Now suppose a month later Marrowgate's customers have paid down their invoices, and eligible receivables fall to $26m. Receivables now support $26m × 85% = $22.1m, and the borrowing base falls to $22.1m + $16.0m − $2.2m = $35.9m. That's below the commitment, so the borrowing base becomes the cap: availability is $35.9m − $28m = $7.9m. The loan's safety moves with the collateral every month.
If the drawn amount ever exceeds the borrowing base, the borrower has an overadvance and commonly must repay the excess straight away.
Cash dominion
ABL lenders commonly control how collections flow. Customers pay into accounts the lender controls, and under cash dominion that cash is swept each day to repay the revolver. The borrower then redraws what it needs. Many facilities only switch on full cash dominion if availability falls below a set level, and the same trigger often turns on a springing fixed charge coverage covenant. The lender gains control just when the collateral matters most.
Field exams and appraisals
A borrowing base certificate is only as good as the numbers in it. So lenders check them:
- A field exam is an on-site review of the borrower's books: testing that receivables are real and collectible, matching invoices to shipments, checking how credits and returns are recorded, and reviewing controls.
- An inventory appraisal by an independent appraiser sets the NOLV used in the borrowing base.
Both are commonly repeated once or twice a year, and more often when the borrower is under stress. They are an ongoing cost, usually paid by the borrower, and one reason ABL suits lenders with specialist teams.
How ABL lenders lose money
ABL losses tend to come from collateral that turns out to be worth less than reported: receivables that were never real or that customers dispute, inventory that has become obsolete, or fraud in the borrowing base itself. Losses can also come from a sudden collapse, where the borrower burns through availability before the lender can react. Field exams, daily cash control and tight eligibility rules are all designed to catch these problems early. When they work, the lender can often be repaid from the collateral even when the business fails.
Key terms
- Asset-based lending (ABL): lending against specific assets, mainly receivables and inventory, rather than cash flow.
- Eligibility criteria: rules that exclude collateral the lender may not be able to turn into cash.
- Advance rate: the percentage of eligible collateral the lender will lend against.
- Net orderly liquidation value (NOLV): what inventory is expected to fetch in an orderly sale, after selling costs.
- Reserves: deductions from the borrowing base for claims that could rank ahead of the lender or reduce the collateral.
- Borrowing base: eligible collateral times advance rates, less reserves.
- Borrowing base certificate: the borrower's regular report of its collateral and borrowing base.
- Availability: the lesser of the commitment and the borrowing base, less the amount drawn.
- Cash dominion: lender control of collection accounts, with cash swept to repay the loan.
- Field exam: an on-site review of the borrower's books and collateral reporting.
Key takeaways
- ABL lends against receivables and inventory, and the loan moves with the collateral.
- Only eligible collateral counts, and advance rates leave the lender a cushion; receivables usually get higher rates than inventory.
- Marrowgate's borrowing base is $27.2m + $16.0m − $2.2m = $41.0m, but availability is capped by the $40m commitment: $40m − $28m = $12.0m.
- Availability is the lesser of the commitment and the borrowing base, less what's drawn.
- Field exams, appraisals and cash dominion protect the lender against collateral that isn't what it seems.
This lesson is for educational purposes only and is not investment advice.