Asset-based lenders: choice for small firms?

• Author: Philbrick, Sam
• Position: Banking

The economy has been rebounding swiftly, and--surprise -now is a great time to be a small- to medium-size enterprise (SME) looking for financing. Unlike the last recession, in which most local banks were slow to get back into the game, lenders this time around are well capitalized. As a consequence, credit markets have greater liquidity, and banks have begun to compete very aggressively for companies in the lower end of the middlemarket that are seeking to borrow $5 million to $20 million.

In addition, new lenders and investors are entering the fray. Several well-known private equity groups recently set up teams dedicated to serving SMEs. For them, this segment offers several advantages, including greater growth potential and better premiums than typically are found at the upper end of the spectrum.

Regardless of the reasons, the increased sources and availability of capital for SMEs is good news. These companies play a significant role in fueling economic growth. Through their ingenuity, product improvements and service developments, SMEs lay the foundation for myriad future business opportunities.

The SME Profile Borrowers at the lower end of the middle-market, by and large, are privately held businesses in which the majority shareholder is the president, chief executive officer and CFO. Frequently, they make a business decision first and worry about the financing later; board approval for finance decisions seldom is required.

SMEs are usually sales-driven and growth-oriented, and their entrepreneurial nature often results in earnings and enterprise value volatility that can preclude traditional financing options. Since most business owners are loath to relinquish equity, and junior secured lenders such as B tranches and mezzanine debt rarely serve this segment, senior debt is the primary form of financing.

SMEs tend to be more cyclical than larger companies because their businesses may be reliant on one product line or customer base. Financing typically stems from a variety of reasons, including equipment purchase, product or market expansion, acquisition, succession planning or change of ownership. Their first foray into financing is often an asset-based structure.

Since they often don't have fully developed finance functions in-house, the owners of such businesses rely heavily on external accountants or attorneys when they need to tap the bank market. These outside advisors typically play a pivotal role in identifying and contacting...