The "enormous supply of capital and liquidity in the market" are further cranking up the competition, according to James G. Connolly, president of Bank of America Business Capital in Glastonbury, Conn. "In fact, there is more supply than demand. It is a good time for companies to put financing in place if they look at all of their options."

The result of these trends has been the recent emergence of a buyer's market in asset based financing . Not only do borrowers, particularly those in a relatively strong financial position, have more lenders to choose from, but the market's increased competition is also driving down the costs of asset-based financing. "In some cases, this financing is 25 to 50 basis points cheaper than it was a year ago," reports Connolly.

A Market in Transition

Asset-based financing is secured by assets that have a readily determined value; usable collateral can include inventory, machinery and equipment, accounts receivable, securities, and real estate. Overall, asset-based borrowing totaled nearly $420 billion in 2005, which represented a 16% growth over the prior year, according to the Commercial Finance Association's 2005 Survey of Operating Statistics. Strong portfolio performance as measured by non-accruals and write-offs were also reported by asset based lenders and factors.

Asset-based lenders fund businesses with annual sales less than $250,000 to more than $1 billion. Credit depends on the type of business and the content and quality of the collateral. Frequently, the credit granted is more than the net worth of the business. Asset-based loans range in size from tens of thousands of dollars to billions of dollars, depending on the borrower's needs and circumstances. In fact, asset-based financing has expanded so much in recent years that deals of $1 billion to $2 billion are no longer uncommon.

Businesses have long relied on asset-based funding to provide cash they can use for operations, acquisitions, debt consolidation and growth. The financing itself can take the form of anything from a loan to a revolving line of credit to an equipment lease. Factoring is also a type of asset-based lending; borrowers using this form of financing sell a subset of their accounts receivable, usually for about 80 percent of the face value. The buyer, or "factor," earns back its investment through collections. It takes on all of the credit risk related to the receivables.

If a company with strong A/R, inventory, real estate or securities finds itself unable to obtain traditional funding based on its cash flow, it should have plenty of asset-based financing alternatives to choose from.

Although this form of debt has long been seen as a good choice only for companies that are unable to arrange cash flow financing, the newly competitive marketplace may change that perception. Asset-based financing is becoming more of a mainstream tool for finance executives looking to fund acquisitions and other deals.

Lower Cost of Capital

Part of the reason that interest in asset-backed financing is growing is that prices are falling. Some lenders argue that asset-based financing and cash flow financing are now on similar footing in terms of costs. "Just because a company uses asset-based lending doesn't mean it has to pay more," says Connolly. Obviously, borrowers with the strongest asset base and performance history have the most flexibility when negotiating costs.

Still, all businesses should carefully evaluate the full slate of costs for each of their funding alternatives -- not just the interest rates. Even asset-based lenders' due diligence fee (which can range from $40,000 to $50,000) may be somewhat flexible. As the market becomes increasingly competitive, lenders will likely become more willing to customize their offerings' fee structure to meet borrowers' needs.

In addition to reducing the cost of asset-based borrowing, the new competition among lenders is affecting everything from the amount a company can borrow against a given volume of assets to the reporting requirements associated with each loan. In the past, the most a company could borrow was generally 80 percent of the value of its assets. Now some businesses can get asset-based loans for as much as 95 percent of the value of the collateral.

Many companies are also finding that they are able to negotiate more favorable loan covenants and less onerous reporting requirements. In general, asset-based financing comes with fewer and more flexible covenants than cash flow financing offers. In many cases, companies have to deal with only one covenant, which requires that the business maintain a certain level of liquidity.

However, to show that they are conforming with the agreement, borrowers often must provide reports on a weekly, monthly or quarterly basis. This is a bone of contention for some. "Doing a weekly certification of asset levels can be invasive," concedes Connolly. But he also notes that borrower reporting can be more flexible when the situation warrants. Some companies might be able to negotiate a less burdensome set of reporting requirements.

Choosing a Lender

Borrowers need to do their homework before choosing a lender. They should look for a financial institution that has experience in their particular industry.

Industry expertise in a lender is especially helpful if the business has unique accounting practices. Companies should also look for lenders with experience handling the particular assets they will use to secure the loan. And it is a good idea to find a lender that has handled deals of similar size and that is sure to have adequate access to the capital markets, particularly if the company is looking to close a large financing deal.

Overall, borrowers should apply the same due diligence to their lenders as the lenders apply to them. The due diligence process can take two to three months, so companies should quickly focus on the best asset based lending candidates.