Can a business with losses get an asset-based line of credit?

Why a loss matters less to an asset-based lender

A cash-flow lender's first source of repayment is earnings. It sizes the loan as a multiple of EBITDA and tests debt service coverage every quarter; conventional bank lenders commonly look for coverage of at least 1.25x. A company that lost money last year has no coverage to test, so the answer is no before anyone looks at the balance sheet.

An asset-based lender starts from a different question: if the business stopped tomorrow, what would the receivables collect and the inventory sell for? The line is sized on that answer through the borrowing base, typically 80% to 90% of eligible receivables, plus inventory at up to 85% of net orderly liquidation value, or roughly half of cost. The loan is repaid from collections of the very receivables it was lent against. Earnings still matter, because a business that keeps losing money eventually consumes its collateral, but they are the second question rather than the first.

A loss year closes the door to most cash-flow lenders. It does not close the door to asset-based lenders, if the collateral and the reporting stand up.

Which losses a lender can work with, and which it cannot

Not all losses read the same way in a credit memo. Asset-based lenders ask what caused the loss, whether it is over, and whether it touched the collateral.

The last row matters most. A lender can live with a company that lost money selling real goods to real customers who pay. It cannot live with receivables it cannot trust. Rising dilution, credits issued to keep customers quiet, or invoices raised before delivery will end the conversation faster than any size of loss.

What the lender asks for in place of earnings

Because trailing earnings cannot carry the credit, the lender builds its protection from other things. Expect most of these in the term sheet:

• Minimum excess availability. The company must keep an amount of unused borrowing capacity at all times, and often at closing too. This is the covenant that matters most to a loss-making borrower, because availability is the cushion that pays for the losses while the plan works.
• A springing fixed-charge coverage test. Instead of testing coverage every quarter, which a company with losses would fail, the fixed-charge coverage test applies only if availability falls below a trigger. See springing covenant.
• A forecast the lender can hold you to. A monthly projection of profit, cash and availability for the next year, showing the route to breakeven. Variances against it are discussed at every reporting cycle.
• Cash dominion. Collections run through a lockbox and pay the line down daily, from the first day rather than only after a trigger. See cash dominion and lockboxes.
• More frequent reporting and exams. Borrowing base certificates weekly rather than monthly, and field exams more often than a profitable company would see.
• Reserves. The lender can add availability reserves for rent, taxes, payroll or anything else that would rank ahead of it in a liquidation.

How pricing and structure change

A loss-making borrower pays for the lender's extra monitoring and risk. The line is more likely to come from a non-bank lender than a bank, because banks have less room to hold a loan to a company with losses on their books; the differences are set out in bank vs non-bank ABL. Non-bank lenders price higher and often charge more in fees, including unused line fees, minimum-usage charges and early termination fees.

Advance rates can be lower, inventory may be limited to a sublimit or left out, and the lender may set a lower concentration cap on the largest customers. A company that turns profitable usually earns its way to better terms within a renewal or two, or refinances with a bank once it has a full profitable year to show. That exit is worth planning from the start: the early termination fee schedule decides what it costs to leave early.

A worked illustration in plain numbers: a distributor lost 400 last year on revenue of 20,000, after a failed product line it has since closed. Its eligible receivables are 3,000, which at an advance of 80 per 100 support 2,400, and its eligible inventory supports another 1,000. A cash-flow lender stops at the loss. An asset-based lender can extend a line of about 3,400 against that collateral, require excess availability of some part of it at all times, take cash dominion, and test fixed-charge coverage only if availability falls below the trigger. The question the lender asks each month is not whether the company made money, but whether the collateral is still there and the forecast is holding.

What the lender will not accept

A few things end an asset-based credit for a loss-making company regardless of the collateral:

• No runway. If the forecast shows the company using up its availability before it reaches breakeven, the line only delays the problem. Lenders look for owners or investors adding equity where the gap is real.
• Unreliable reporting. Books closed late, agings that do not tie to the general ledger, or inventory counts that do not match the system.
• Liens ahead of the lender. Unpaid payroll or sales taxes can rank ahead of the lender or force a reserve, and any other lender with a filing on receivables has to be paid off or subordinated at closing. See UCC blanket liens.
• Losses paid for by stretching others. A company funding its losses by holding back suppliers or tax deposits has already spent the cushion the lender is counting on, and the payables will surface in the first field exam.

Preparing a file that lenders will read past page one

The documents are the same as for any asset-based line. Midas Partners's checklist asks for the AR aging by customer with days outstanding, the AP aging, the balance sheet, the P&L and year-to-date P&L, the debt schedule and existing liens, an inventory report where inventory is in the base, and optionally bank statements and two to three years of tax returns. What differs is the explanation around them.

• Name the cause of the loss in one paragraph, with the figures that isolate it, and show the months since it ended.
• Build a monthly forecast of profit, cash and availability, not just profit.
• Reconcile the aging to the balance sheet before the lender does it for you.
• Separate one-time costs from recurring ones on the P&L, the same discipline as EBITDA add-backs, and be conservative about it.
• Say what the owners are putting in, if anything, and when.

This is a file that benefits from breadth. Of the 1,800+ lenders in Midas Partners's book, 235 write asset-based loans and lines, and their appetite for a recent loss varies from none to routine. Senior bankers run every Midas Partners engagement. Once the documents are in, Midas Partners builds the full lender package in a day: the financing model, the lender presentation, the blind teaser and the underwriting memo, and a senior banker checks every page before the client approves it. Lenders that fit see the blind teaser first, and the client approves each by name before it learns who the company is. For companies that also need to move out of a bad year's debt, refinancing after a down year covers the term-debt side, and how we underwrite describes how Midas Partners reads a file before any lender sees it.