Introduction
Asset-based lending is a financing tool that is particularly relevant to industrials because the sector's tangible asset base (receivables, inventory, equipment, real estate) provides collateral that supports borrowing capacity beyond what EBITDA-based metrics alone would justify. For PE sponsors structuring industrial LBOs, ABL facilities provide a revolving credit line that supplements term loan leverage, providing liquidity and flexibility that is especially valuable during cyclical downturns when EBITDA-based borrowing capacity contracts.
Understanding ABL mechanics is important for industrials bankers because it affects deal structuring, leverage optimization, and the attractiveness of asset-heavy companies to PE buyers.
How ABL Works: The Borrowing Base
- Borrowing Base (ABL)
A formula that calculates the maximum amount a company can borrow under an asset-based lending facility by applying advance rates to the liquidation value of eligible collateral assets. The typical borrowing base for an industrial company is: (Advance rate on eligible receivables x Eligible receivables) + (Advance rate on eligible inventory x Eligible inventory) + (Advance rate on eligible equipment x Orderly liquidation value of equipment). The borrowing base is recalculated monthly (or weekly in some cases), and the company can only borrow up to the lesser of the borrowing base or the total commitment amount. As the company's asset values change (receivables grow with revenue, inventory fluctuates with production), the available borrowing capacity adjusts automatically.
The standard advance rates for industrial companies are:
| Collateral Type | Typical Advance Rate | Eligibility Criteria |
|---|---|---|
| Accounts receivable | 80-85% | Domestic, <90 days past due, non-concentrated |
| Finished goods inventory | 60-65% | Marketable, not obsolete, properly valued |
| Raw materials inventory | 50-60% | Standard materials with resale value |
| Work-in-process inventory | 0-40% (often excluded) | Depends on degree of completion |
| Machinery and equipment | 50-75% of OLV | Appraised orderly liquidation value |
| Real estate | 50-65% of appraised value | Fee-simple ownership, environmental clean |
ABL vs. Cash Flow Lending
Industrial LBOs typically use both ABL facilities and cash-flow-based term loans, with each serving a different purpose.
Cash-flow-based term loans provide the primary acquisition financing, sized as a multiple of EBITDA (typically 2-4x for cyclical industrials). The term loan amortizes over 5-7 years and is repaid from free cash flow. Pricing reflects the company's credit profile and leverage level (typically SOFR + 350-550bp for industrials).
ABL revolvers provide working capital financing and liquidity reserves, sized based on the borrowing base formula. The revolver is drawn and repaid as working capital needs fluctuate (drawn when inventory builds, repaid when receivables are collected). ABL pricing is typically lower than cash-flow-based pricing (SOFR + 150-300bp) because the lender has collateral protection.
The combination allows the PE sponsor to maximize total leverage while maintaining adequate liquidity: the term loan provides the primary debt capacity based on earning power, while the ABL revolver provides the day-to-day liquidity and seasonal flexibility based on asset values.
Practical Considerations for ABL in Industrials
Appraisal requirements. ABL lenders require periodic appraisals of inventory and equipment values (typically annually when the facility is performing well, quarterly if the company is under stress). These appraisals add cost and administrative burden but are essential for maintaining the borrowing base calculation. The orderly liquidation value (OLV) of equipment is typically 50-70% of replacement cost, reflecting the discount that would be realized in a controlled sale process.
Inventory eligibility exclusions. Not all inventory qualifies for the borrowing base. Slow-moving inventory (items that have not sold in 12+ months), obsolete inventory (products that are no longer manufactured or have been superseded), consignment inventory (owned by the customer, not the company), and in-transit inventory (not yet received at the company's facility) are typically excluded. For industrial manufacturers with complex inventory profiles (multiple product lines, seasonal patterns, custom orders), determining eligibility requires detailed analysis of inventory composition.
Springing covenants. ABL facilities typically do not impose maintenance covenants (like leverage ratios) unless the company's liquidity falls below a specified threshold (usually 10-15% of the facility commitment). When this threshold is breached, a "springing" fixed charge coverage ratio covenant activates, requiring the company to maintain minimum cash flow coverage. This structure is borrower-friendly because it imposes financial discipline only when the company is under stress (when the covenant matters most) while allowing operational flexibility during normal times. For cyclical industrials, the springing covenant structure is preferable to maintenance covenants because it avoids the technical defaults that can occur when cyclical EBITDA compression pushes leverage ratios above covenant levels even when the company has adequate liquidity to service its debt.
Lender control and dominion provisions. ABL facilities include provisions that give the lender increasing control over the company's cash management as financial performance deteriorates. At the most restrictive level, "cash dominion" requires all cash receipts to sweep automatically to the lender, with the company reborrowing under the revolver for daily cash needs. This arrangement ensures the lender maintains control over the collateral proceeds but can constrain the company's operational flexibility. Understanding these control provisions is important for deal structuring because they affect the practical liquidity available to the company during stress periods.
Availability reserves. ABL lenders also impose reserves that reduce the available borrowing capacity below the calculated borrowing base. Common reserves include rent reserves (to cover upcoming lease payments), dilution reserves (to account for customer returns, credits, and allowances that reduce the effective value of receivables), and seasonal reserves (to provide additional cushion during periods of historically lower asset values). These reserves are negotiated at closing but can be adjusted by the lender if the company's financial performance deteriorates.
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