Asset-based borrowing for any company is a blessing and a loss of control at the same time. This article will discuss the key points you need to understand about asset-based lending. First, however, some background.
Book Trade Tradeoffs
Traditionally the publishing industry has been a slow-pay, low-margin business complicated by seasonality and returnability. This is a model for a challenging cash flow.
To be successful, a publisher must recognize these facts and make every effort to counterbalance book trade sales by selling into other channels that have faster payments, no returns, higher margins, and/or higher prices.
Nevertheless, a new season’s titles sell rather easily in the book trade. Buyers place orders in advance of publication and the established patterns of buying at wholesale and retail take our product into the market quickly. When we use a distributor or independent sales reps, it’s easier and faster to sell into the book trade than into some of the other types of markets mentioned above that require a finished product before making a buying decision.
The Cash Predicament
Let’s create an example. Imagine that you’re a new trade book publisher (or maybe you really are). You start with cash and ideas. Over a year or two, in the process of producing new titles and making sales, you will gradually convert all of your cash into accounts receivable, inventory, and prepublication costs.1AQ2FP>
Ideally, the accounts receivable and inventories will now be larger than the cash you started with. Yet, other bills are now due, and you need to print more books even if there’s no cash left in the till. If you’re lucky enough to have a best-seller, you may have to pay two or three printing bills before you collect your first A/R.
This is where asset-based lending comes in–to bridge the gap between accounts receivable that won’t be collected until some time in the future and the bills that have to be paid today.
What Is Asset-Based Lending?
Asset-based lending arrangements are generally a simple and good source of cash for a small business that needs seasonal working capital and capital for growth of current assets. In other words, they’re a source of short-term working capital and not a source of long-term investment capital. Typically, asset-based borrowing involves a revolving line of credit with a financial institution, with the amount of the credit based on the value of an asset–such as accounts receivable and inventory–up to a defined limit.
The difference between a revolving line of credit and a term loan is that a term loan provides cash only once and then requires monthly debt service payments, while cash availability on a revolving line of credit will increase and decrease in relation to the asset base that the company is borrowing against.
As an asset-based borrower, the company must understand the lender’s reporting requirements, interest rates and fees, loan covenants, and the asset-based loan securitization.
An asset-based lender loans money to make money, so read the loan documents closely. Asset-based borrowing agreements will specify what asset the company is pledging as the collateral base for the revolving line of credit. Generally, borrowers will have to provide personal financial statements and personal guarantees in addition to pledging the assets of the company. The borrowing agreement will usually renew annually and contain loan covenants that must be understood, reviewed on a regular basis, and followed by the borrower.
Choosing an Asset-Based Lender
It’s very important to choose an asset-based lender that will function as your business partner and vital to choose one with a quality reputation in the local business community. When looking for potential lenders, seek out local commercial banks or specific asset-based lenders who loan on A/R, inventory, etc.
The Small Business Administration provides a directory of all the Certified and Preferred Lenders they work with at http://www.sba.gov/gopher/Local-Information/Certified-Preferred-Lenders. This listing, by state, will show you 25 or so lenders, including banks and other financial companies that do asset-based lending in your state.
Also check out http://www.sbaonline.sba.gov/financing/indexloans.html, the home page for various SBA guaranteed loan programs you may qualify for. If you would like the descriptions in one place from the lender’s perspective, see http://www.sbaonline.sba.gov/library/pubs/lenders.html.
The lender you choose should have the desire and the ability to understand the publishing industry, your publishing company, and the business cycles of your borrowing base. Remember: Lenders make loans on what they understand and they may not understand the publishing business because it differs from most other businesses they lend to. Publishing accounts receivable are collected more slowly and returns have to be considered. Inventory has only limited value when a title does not have ongoing sales, so the lender can’t count on selling a book the same way they can count on selling a building or vehicle. Plus, after a title is published, prepublication costs are expensed rather than capitalized, removing the revenue and cash generating assets from the balance sheet. Lenders find these circumstances difficult to evaluate.
Interest & Associated Costs
While asset-based loan costs vary from lender to lender, most include a nonrefundable commitment fee, interest fees, and annual renewal fees, and they may require minimum monthly outstanding loan balances.Additional loan fees may include “out of formula” or “covenant compliance” fees, unused line of credit fees, and loan termination fees. The fee structure of every loan will be different; some lenders will charge more in loan interest and not charge for audit fees and unused line of credit fees, while other lenders will have low interest fees and charge for all the other services.
How It Works
An asset-based borrowing formula tells both the lender and the borrower what is available to borrow against. Although the borrowing base can be accounts receivable, inventory, or other liquid assets, it will most likely be accounts receivable for publishers. The eligible borrowing base is current accounts receivable, which means invoices less than 90 days old. Then the eligible borrowing base is reduced by the lender’s required reserve requirements, ineligible assets, and interest payments when due.
Keeping the revolving line of credit borrowing base as high as possible requires keeping ineligible assets as low as possible. Ineligible assets include old current assets (including old inventory and old A/R), customer concentrations higher than 10% of the sales base, customers’ lack of creditworthiness, out-of-country sales or inventory, and affiliated or common shareholder transactions.
After determining what’s available in the borrowing base, you’ll complete the lender’s “Borrowing Certificate” form, which shows the current borrowing base, the availability on the revolving credit line, and the amount of the advance requested. The borrowing certificate must be signed by an authorized representative of your company. Once the lender gets the properly completed borrowing certificate and approves the advance, it should fund the advance request within 24 hours.
Borrowers must provide weekly, monthly, and annual reporting. Weekly reports are required on sales, collections, and ineligibility analysis. Monthly required reports involve internally generated financial statements with detailed accounts receivable and accounts payable information. Annual reports must include tax returns, corporate resolutions, and material on any major changes in the business such as inventory damage.
Even with all the internally generated reports, the lender will want to send out its own auditors regularly. Lender’s audits are routinely done quarterly and on-site. A quarterly audit includes a review of employer federal and state employee tax filings (Form 941 and state tax forms), a search for unrecorded liabilities, bank statements to insure all deposits are going to the lender, reviews of major borrowing agreement covenants to insure that they are within guidelines, and interviews with the key company employees and the owner.
With revolving lines of credit, all payments collected against the pledged assets must be sent to a lockbox controlled by the lender. All non-collateralized funds received by the borrower–such as corporate tax refunds, insurance settlements, and proceeds for the sale of assets–must generally be deposited with the lender to reduce the outstanding loan balance.
After going through this process, you will truly understand that a lender always gets its money back plus interest–one way or another!
A Co-Founder and Publisher of two successful trade book publishers–HPBooks and Fisher Books–Howard W. Fisher recently started The Fisher Company, a consulting company that helps growing publishers with financial matters, operations, business development, and mergers and acquisitions. He is a former PMA President and a frequent PMA University presenter.
Daniel R. Siburg is a CPA at The Fisher Company. He can be reached at email@example.com.