Financing deals with asset-based lending

Asset-based lending (ABL) is increasingly being used as part of the funding mix and now effectiveness post-deal is also attracting deal makers.

For dealmakers, the post-acquisition phase can be as stressful – if not more so – than putting together the original transaction, and finance is often a root cause of this pressure.

While managers often focus on drawing together a funding package to buy the business, the capital needed in the post-deal phase can be overlooked. Once the initial adrenaline rush of the deal has passed, the cold light of day often reveals that little extra money is available to support consolidation and growth, i.e. the very reasons the deal was often conducted in the first place.

An increasing number of dealmakers are overcoming this issue by structuring packages comprising several types of funding. This can include private equity, bank loans and asset-based lending, the latter of which is designed to support the post-deal phase in addition to the initial acquisition.

While private equity and loans have funded deals for many years, asset-based lending is a relative newcomer to M&A transactions. However, this highly flexible form of funding is rapidly growing in popularity thanks to its ability to provide ongoing financial support long after the acquisition has taken place.

“Debt raised from ABL relates to the value of the assets – be they receivables, inventory, plant and machinery or property – but a lot of the funding is done on a revolving basis, particularly receivables and inventory, rather than on a reducing or amortising term basis,” said Chris Hawes, managing director of asset-based lender Venture Structured Finance. “This means the facility will grow post-acquisition as the company does, reducing the undue strain placed on a company’s cash flow by a high level of amortisation.”

Indeed, a criticism of leveraged deals is that amortisation considerations can place added pressure on a business’s financial structure and management team – something they may not have experienced before. “While leverage can bring positive benefits, for example by focusing people’s minds on making sure the business is run tight and lean, that leverage can place too much stress on a company and represent distraction from other operational duties,” Hawes said.

“Rather than seeing ABL as a competitive funding channel, private equity firms support the use of this form of finance because it is less covenant-heavy,” Hawes said. “This removes the concern that a whole series of covenants will be tripped at various stages in the business’ life cycle. Although the covenant structure is dependent on individual case, stronger deals tend to be more covenant-light and therefore less onerous than a senior debt-based acquisition,” added Hawes.

Related: The changing face of ABL

This financial flexibility is especially relevant if a business needs to implement operational changes after a deal, which often occurs when a private equity firm is involved. An element of asset-based lending within the deal structure can give managers the breathing space to make necessary changes.

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