adminacquisition of other businesses.
This has given rise to asset-backed financing commonly called Asset Backed Security.
An asset-backed security is a fixed income instrument structured as a securitised interest in a pool of assets.
In the US, the 2010 Dodd-Frank Financial Reform Act broadly covers for defined asset-backed securities that encompass all securitisations:
“. . . a fixed-income or other security collateralised by any type of self-liquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset, including
(i) A collateralised mortgage obligation;
(ii) A collateralised debt obligation;
(iii) A collateralised bond obligation;
(iv) A collateralised debt obligation of asset-backed securities;
(v) A collateralised debt obligation of collateralised debt obligations; and
(vi) A security that the Commission, by rule, determines to be an asset-backed security for purposes of this section.’’
However, traditionally, finance professionals use the term more narrowly to refer to securitisations other than mortgage-backed securities (MBS).
In the banking world ABS is now viewed as a specialised method of providing structured working capital and term loans that are secured by accounts receivable, inventory, machinery, equipment and/or real estate.
This type of funding is great for start-up companies which have limited funding options, refinancing existing expensive short loans, financing growth, mergers, acquisitions, and management buy-outs (MBOs) and management buy-ins (MBIs).
A management buy in is the acquisition of a business by a management team, which does not run that business.
It is often an alternative to management buy out considered by a team unable to buy its own business. An MBO or MBI can use the assets of the target company to raise funding to finance the acquisition of the business.
This is ideal as it is structured in such a way that the transaction is self-financing in that MBO team reduces its own financial contribution. This reduces their personal financial risk but increases the transactions overall financial risk since the company still has to find working capital whilst a significant portion of its liquid assets have been pledged in acquiring the company.
A practical and popular example of asset-based finance would be purchase order financing; this is ideal and attractive to a company that has over stretched its credit limits with suppliers/vendors and has reached its borrowing capacity at the bank.
The inability to finance raw materials to fill all orders would leave a company operating under capacity.
The asset-based lender finances the purchase of the raw material, and the purchase orders are then assigned to the lender.
After the orders are filled, payment is made to the lender who then deducts its cost and fees and remits the balance to the company.
The disadvantage of this type of financing, however, is the high interest
The true purpose of asset based finance is to funding short-term gaps which are normally covered through overdrafts or revolving lines of credit.
An asset based business line of credit is usually designed for the same purpose as a normal business line of credit — to allow the company to bridge itself between the timing of cash-flows of payments it receives and its expenses. Factoring of accounts receivables [debtors], is a specialised form of asset-based lending (which uses inventory or other assets as collateral).
The lender mitigates its risk by controlling who the company does business with to make sure that the company’s customers can actually pay.
This means the company’s credit control function and policies are partly controlled by the lender because the lender should ensure the quality of the debtors is credit worthy.
Lines of credits may require that the company deposit all of its funds into a “blocked” account. The lender then approves any withdrawals from that account by the company and controls when the company pays down the line of credit balance.
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This article is provided “as is” for informational purposes only, not intended for trading purposes or advice. Prior to execution of any security trade, you are advised to consult your authorized financial advisor to verify the accuracy of all information. Neither GMRI Capital nor any independent provider is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein.
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