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Mark Meloy:
Hello, I'm Mark Meloy, CEO of First Business Bank. Welcome to the First Business Bank Podcast. Today, we're talking about Asset-Based lending, when is it the right option for a business? In another podcast, we already talked about commonly misunderstood business financing strategies. And in that conversation, we briefly touched on Asset-Based lending. Today, we're going to go a little bit deeper. Businesses, often face working capital challenges that come in all shapes and sizes, accounts receivable and inventory turns along with many other external factors, all can play a part in this dilemma.
Mark Meloy:
Frankly, there are many scenarios where conventional bank financing just does not fit and the alternative we are talking about today, Asset-Based Lending can often provide the best solution. I'm joined by one of my experts from the First Business Bank team who will offer some thoughtful insight regarding working capital solutions. Mike, I'll have you introduce yourself and then we'll get the conversation started.
Mike Colloton:
Sure. Good morning, Mark. Thank you very much. Yeah. My name is Mike Colloton. I'm with First Business Bank's Asset-Based Lending group. Been doing this type of work for a very long, long time and interested in discussing this with you this morning, Mark. Thank you.
Mark Meloy:
Great. Mike, we had these conversations over the years, but for our audience's sake, what is Asset-Based Lending? How is it different than maybe a common bank line of credit?
Mike Colloton:
Yeah. From a big picture perspective, Mark, it really is the same as a bank line of credit. Asset-Based Lending is a revolving secured line of credit that's for a business secured by accounts receivable and inventory and using a borrowing base. So from that perspective, it's very similar to what First Business Bank or any bank would offer to their clients. What is unique is how we look at a company and in offering an Asset-Based Lending line of credit. It has more to do with the timeframe that the company needs money and their ability to get a traditional line of credit from a traditional bank source.
Mark Meloy:
The way you go about it is unique, because it's a much deeper dive into the, what I'll call the quality of the collateral. Let's say in particular, our accounts receivable and inventory, is that a fair statement?
Mike Colloton:
Yeah, absolutely. They're the businesses that we are lending to, usually are having some performance issues maybe they'd have a bad year or two where cashflow wasn't exactly where they wanted it to be or where the bank would like it to be. They may be going through a high growth situation or the balance sheet may just be very leveraged due to maybe an acquisition that's happening right now, or that happened recently. Or two, money being taken out of the business for dividends, for ownership, maybe to pay taxes. So there's something going on at the business right now where traditional financing is really not an option. Because of the way that Asset-Based Lenders review and look at the collateral, dive into it much more deeply than a traditional bank we are able to finance some of those businesses that don't fit for traditional banks.
Mark Meloy:
Yeah. I used to describe to people that I consider the three optimal scenarios where Asset-Based Lending works the best and you've touched on this already in what you just said. But there's operational performance challenges that are going on, might be rapid growth, and sometimes it's an ownership change. Is that a fair way to describe the scenarios where a traditional lines of credit maybe don't work, but Asset-Based Lending does?
Mike Colloton:
Yeah. That's exactly where we see ourselves getting most of our deals and most of our opportunities is, is those type of scenarios. So, a company may be going through an acquisition, maybe a management buyout, or they've had significant growth and need a larger line of credit and their existing bank would like to help them and wants to help them. But because of that high growth or because of the leverage that the current situation is causing, or again, maybe because of just cash flow issues relating to the business over the past year or two, the existing bank is saying, listen, we'd love to work with you but we really can't go going forward. We need you to find new financing.
Mike Colloton:
And oftentimes those companies will come to other banks and talk to them, and those other banks will say the same thing. And we'd love to have you as a client, but we need to see leverage below a certain number, or we need to see a full fiscal year of good cash flow and earnings. The company right now might not be in a position and probably isn't in a position to do that immediately. And that's where an Asset-Based Lender can provide that line of credit. And again, the way that we're able to do that is, we're looking much more closely at the collateral and at the current cash flow. We're not as concerned that traditional bank with leverage on the balance sheet, with the historical earning. Those things, we look at them but that's not really where we're focused.
Mike Colloton:
We're focused very heavily on the actual collateral itself. So we dive very deeply into the accounts receivable, much more deeply than a traditional lender, same with the inventory. And then, oftentimes we will and do provide financing on machine and equipment and real estate, not all Asset-Based Lenders do, but some do including First Business and that can help provide additional liquidity for the business if they've got those assets where they've paid down those loans. The other thing that we do is, in looking at those very closely is we have our own due diligence staff which really, typically, is accountants or CPAs that review those things very carefully and do a lot of testing on the receivables and inventory that banks don't do on a regular basis.
Mark Meloy:
You talk about collateral and that's a great definer. I think of what you all look at, hence the name "Asset-Based" because it really is collateral dependent, the quality of the collateral and that kind of thing. So that's a great way to distinguish what you do and what you're interested in versus the traditional bank, that's maybe going to call itself a cash flow lender first and a collateral lender second kind of thing. You guys are really collateral first and cashflow matters and maybe is like a one A and a one B is how I think of it with Asset-Based Lending.
Mike Colloton:
Correct. Yep.
Mark Meloy:
Your new business often comes through a referral source, which is different than the way that a lot of other bankers go about business. And when I say that, I mean, attorneys, accountants, management consultants, why is that?
Mike Colloton:
Well, traditional banks as you know Mark, they are calling on companies that need banking services. So they'll go out to businesses, they'll talk to them, they'll try to find on their own businesses that need their financing. And oftentimes, they talk to companies and they'll be talking to for a year or two or three to build that relationship and to hopefully get the opportunity to finance that company. Because pretty much every company needs a bank, if not for at least the credit side of it certainly, for the treasury management side of it. So there's opportunities for bankers to do that. With the financing that we do, it's very specific to a timeframe. So, the companies that need Asset-Based Lending probably six months ago, they didn't need it and a year from now, they might not need it.
Mike Colloton:
So trying to call in businesses directly to find those types of opportunities is difficult. It can be done, but it's much better to talk to the, what we call Centers of Influence, the attorneys and accountants and investment bankers, turnaround consultants, and other banks. Quite honestly, a lot of the opportunities we get are from banks that are, including our bank that are talking to businesses and get the opportunity to look at the financing. And unfortunately look at it and say, oh geez, I can't help this business right now, but here's the lender that is happy to do your deal and would be very interested in providing that financing going forward.
Mark Meloy:
That's a great explanation, Mike. So if I'm a business owner and I'm experiencing some operational difficulty, if you will, just use that as one of the scenarios we talked about before. Maybe my incumbent bank is not so crazy about doing business with me right now, and I'm now looking for an alternative and my account or my attorney or a consultant who I know is pointing me towards an Asset-Based Lending alternative. What should I expect in that sort of launching into that kind of relationship if I'm a business owner?
Mike Colloton:
Well, I would say that certainly there's going to be a lot more scrutiny in a good way of the assets of the business and of the performance of the business than what a bank would do. The scenario you just described there has been maybe some performance issues, so a traditional banker when they get a new opportunity, they're going to spend time looking at performance but it's probably been pretty good. So they spend some time on it and explain it, and there's not a lot of explaining that needs to be done. Certainly, with a company that's had some performance issues, there's a lot more questions as to what happened and why. And more importantly, what's going to be different going forward.
Mike Colloton:
What has changed or what are you in the process of changing to get the company back to a breakeven or better cash flow position? So there's just more time spent on working with Asset-Based Lender both up front and going forward. I will say though, that I think that a lot of ownership actually appreciates that. Many of the companies we talk to, the current assets, especially that they're not being managed particularly well. Sometimes that's part of the liquidity issue is they have a lot of inventory that's just sitting around and it's not moving. It's not turning or a lot of receivables that are past due, and they're just not doing a great job on collecting those receivables.
Mike Colloton:
And the existing bank might not want to lend on those receivables but if they can get that money collected, they can turn that into cash to run the business. So when we come in on the Asset-Based Lending side and start asking more questions and probing a little more into some of those things, sometimes the accounting people, they may not appreciate the quizzing on that side of it. But the ownership understands ultimately that it's a good thing to manage those fixed assets much more carefully. I had a client quite some time ago at Grand Rapids, we had as an Asset-Based Lending client. And I remember quite well that the accounting person there was not exactly thrilled with having to go through all the work that we needed to do up front.
Mike Colloton:
But we got the deal done and they were happy with the results that gave the company a lot of extra liquidity to run the business. I did stay in touch with that owner and probably 10 years later, we got together for lunch one day long after they were back to traditional bank financing. And he explained to me that he is still having their accounting people do the same type of reporting internally, not to their bank but internally they had to do to us at the bank that I was at that point in time on the Asset-Based Lending side, because he said it made them manage their receivables and their inventories much better. So he really did appreciate that discipline that instilled in them.
Mark Meloy:
Yeah. That's a great story. I'm always amazed that the number of clients that you all have in the Asset-Based Lending group that are ready or able to, I say graduate to traditional bank financing. But they opt to stay in the Asset-Based Lending structure because of the absolute discipline that the processes provide them both from really the efficiency of the operation and overlooking it in the fiduciary responsibility of management. It really is an interesting play out sometimes with those relationships.
Mike Colloton:
It is, it is. And that's something we haven't touched on, but it is a little more expensive to use the Asset-Based Lender because of the time and effort we put into managing our clients, and the relationships, and the assets. So there is some cost involved and there's more time involved, but a lot of the time that can be good time. We're asking more questions, we're more engaged with our clients than what a traditional and can be. We have to be. And some ownership of businesses enjoys that, that they've got someone that's actually, wants to know what's happening in their business and hopefully can be some of a strategic person that can work with them on the business.
Mike Colloton:
Not that there's a lot of bankers out there that do that and do it well. But there are clients that we have that could very easily go to back to traditional bank financing and do choose to stay with us. Another reason can be we do offer a little bit higher advance rates than what a traditional bank would both on the receivable side and often on the inventory side as well. So there can be some liquidity advantages to working with an Asset-Based Lender, also.
Mark Meloy:
Mike, is there a particular industry or types of companies that tend to be better suited for Asset-Based Lending and I guess, conversely, are there industries or types of companies that maybe aren't good Asset-Based Lending options? They might be better off in a, say a counter receivable or factoring type of scenario.
Mike Colloton:
Yes, absolutely. As we described, an Asset-Based Lending line of credit is based on business to business receivables primarily, and then the inventories. So any business that doesn't have those type of assets is not going to be typically a good prospect for us. Let's say a restaurant or a hotel or a condo project or a golf course or any a type of just playing real estate type of opportunity, we're happy to do real estate and many Asset-Based Lenders are, but usually not on a standalone basis. We're looking for that revolving line of credit.
Mike Colloton:
So those types of businesses just because of the collaterals are not a good fit for us. Most Asset-Based Lenders, including at First Business Bank, we don't usually want to lend on progress billings or percentage to completion billings. There are ways to make that work but it doesn't work oftentimes. So that takes a lot of contractors out of the equation as well. Those are the biggest ones that don't fit because of how we do business and where we are located to a certain extent. We've always had a lot of success, financing manufacturing company companies. They have the business to business receivables, they have inventories and they usually need to finance those, and any type of distribution business as well is a good fit.
Mike Colloton:
Certain service businesses are very good too. Certainly, trucking comes to mind, staffing, those are probably the two that we've done the most of over the years. So those are the ones that we see primarily, but there are other companies that we find a way to make work for both them and for us. We're open to any type of situation provided we can understand the collateral and make sure we know what the collaterals value is and that going forward, we believe that the cash flow is going to be positive based upon reasonable assumptions.
Mark Meloy:
So as a business leader, an owner that's evaluating multiple Asset-Based Lending providers, which they look for, what were the pros and cons to be aware of from lender to lender?
Mike Colloton:
Well, most of the companies we are talking to, liquidity is the big issue. The Asset-Based Lender that can give them the most liquidity is usually going to be the one that's going to have a leg up on everyone else, whether that's higher advanced rates on the receivables or inventory, whether that's maybe being able to provide a term loan on equipment or real estate and increasing that amount that they've got on that. So, that's always a big piece of the puzzle. And then obviously costs comes into play. Almost all Asset-Based Lending is going to be a little more expensive than traditional bank financing. But certain Asset-Based Lenders, including usually bank owned, Asset-Based Lenders, like First Business Bank are going to have a lower cost of capital.
Mike Colloton:
Therefore, it's going to be a little bit cheaper to work with an Asset based lender that's owned by a bank than one that might be owned by a private individual or a private equity group. Obviously, those companies need either use their own equity or borrow from a bank, so their cost of funds is going to be a little bit higher. So those are the two bigger issues. Working with a bank-owned Asset-Based Lending company can be advantageous in that you are typically working with just maybe one or two institutions. If it's bank owned, they can oftentimes provide all the treasury management business. They can provide term debt on the equipment of real estate. So, sometimes it's simpler from an ownership perspective and the company's management to be working with a bank on Asset-Based Lending company. But again, there are opportunity for these other Asset-Based Lenders to do a good job and sometimes provide some financing, then a bank own an Asset-Based Lender can't.
Mark Meloy:
The one thing that we didn't necessarily touch on, but it also exists too is the, say convenience or the ease of change into a traditional bank financing scenario. If you're a bank owned Asset-Based Lending company, there's been a number of Asset-Based Lending clients that now are bank clients as they've worked their way through the issue that brought them to you in the first place. And I think been a great setup both for the client and for business banking, particular in terms of how that has worked out over time.
Mike Colloton:
Yeah, absolutely Mark. Yes. With every one of our clients, we expect somewhere in the next 3, 4, 5, 10 years, they're going to be a traditional bank client. That's kind of the expectation. We're trying to get the client from point A to point B and point B is usually going back to traditional bank financing. Sometimes it's selling the business, but yeah, working with our group or other bank-owned Asset-Based Lenders, there's a very easy transition from the ABL group back to the traditional bank world. You're not moving all your treasury management. You're still working with the same institution. Oftentimes you're working with a lot of the same people, maybe not the exact same people, but many of the same people in the process. So, that's a real advantage to the business owner. Certainly, yes.
Mark Meloy:
Yeah. One thing also that I think is an important clarification about your business is that you're not a workout group. I always describe you as a work through group. There's an issue at hand or there's something going on right now, all the things that we talked about before, and you said it, when you said kind of get from point A to point B, that's kind of your mission is to be that provider for that company on that journey. And if they fulfill their plan and we're part of it, it's usually always success at the end. It's not as often is it crisis or a liquidation that is important. That can happen. Not every plan is perfect, but you guys really have a great record of helping companies get through that issue that's at hand.
Mike Colloton:
Sure. Yeah. I would say we're just the opposite of a work group. Every new client we bring in, we want to be their lender. We like this business. We want to be part of the solution to their issues and help them work through them. We're going to provide them with a bunch of liquidity up front that's otherwise the deal's not going to work for us. So every new client we bring in, if they had any issues with payables or pass due taxes or debt that needs to be restructured, we're going to work through all those issues up front and make sure that they're all cleaned up and all covered. So that going forward provided they could hit their plan, which they need to do they should be fine. So yes, it's just the opposite of, workout is typically we want you out of the bank and here are the things that are going to happen to make that work and that's not what, again, we're just the opposite of that.
Mark Meloy:
Yeah. Like what you said about that you want to be there is, because I think that, the baseline is you have to believe the plan that management and ownership have for the go forward basis. Because if you don't, you're not going to step in. You're not going to make a proposal. You're not going to be the provider kind of thing. So, you're there with intent and with purpose. I think that's a great, great description.
Mike Colloton:
Yep. Absolutely.
Mark Meloy:
Mike, thanks a lot for taking the time today. I always enjoy talking with you about your industry and your thoughts and experiences. I think are very valuable for our audience to understand Asset-Based Lending and solving working capital needs. And to your audience, thank you also for listening to the conversation, I hope you found the topic helpful. And join us next time on the First Business Bank Podcast.
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