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Asset Based Lending: The Limitations and Challenges of ABL

msts insight

Asset-based loans (ABL) are a tempting alternative to traditional lending for businesses, but they also have limitations.

As we discussed previously, ABL is a common way for businesses to increase cash flow in order to expand and grow. With more than $465 billion worth of ABL in 2018, there was seemingly no shortage of capital from banks. However, the limitations, challenges and risks of the practice become more evident in times of economic disruption. 

An ABL is one of the lowest cost loans and often seem appealing at face value, until businesses realize the downside. Though many of the less attractive elements of ABL have been solved by innovative FinTech applications in recent years, the complexities of the practice still deserve a closer look. 

The challenges of ABL 

Before leveraging the future of your accounts receivable (A/R) assets with ABL, take time to weigh the drawbacks. Remember: 

  • ABL is “all or nothing.” When entering into an ABL agreement with a bank, your entire A/R book becomes property of the bank. There is no “splitting” or excluding certain accounts — even the accounts that don’t ultimately factor into the size of the loan become owned by the bank and cannot be used as leverage or collateral in other loan agreements. And because ABL is a secured loan, the practice doesn’t help a business build credit like traditional business loans. 
  • ABL limits borrowing ability. From the outset of an ABL agreement, a bank will begin to scrutinize your assets and exclude certain accounts from the collateral. Many businesses are surprised they can only borrow a fraction of the value of their assets — an especially frustrating factor considering the “all or nothing” nature of ABLs. 
  • ABL is resource heavy. The ABL process takes a considerable amount of upfront work, as well as regular maintenance. The record keeping and accounting involved can be a challenge, even for experienced A/R teams. For example, imagine a business where A/R is upended by past due invoices as a result of a crisis. This already strained business must now undertake the lengthy process of documenting all A/R for the bank. Many businesses fail to appreciate the amount of heavy lifting involved in ABL upkeep. 
  • ABL is risky. The amount and terms of an ABL depend on the asset mix in a business’ A/R book. But the health of any business operation is dependent on the economy. If a supply chain is disrupted or a recession occurs, accounts inevitably shrink and disappear. As accounts decline, so can the size of the ABL. Having a source of cash flow so dependent on the health of customers and the overall economy is extremely risky. Additionally, collecting these outstanding debts to satisfy the loan puts extra pressure on A/R and finance teams. 

Business leaders should pause before entering into an ABL agreement. The limitations and challenges that are attached to the practice can far outweigh the benefits. Further, the practice of ABL itself is facing disruption in the form of new payments technology that eliminates many of the pain points of ABL, while offering similar benefits and more efficiencies. 

To explore the basics of ABL, read part one of our series or learn more about the technology that’s helping businesses break the ABL cycle. 

Sign up to receive part III directly in your inbox.

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