Over the past two decades, asset-based lending (ABL) has evolved from a little-known financing option, which originated in the US, to a mainstream funding solution. Over that same period, ABL has increasingly become a source of funding for M&A. It is now recognised as an established part of the private equity funding mix, enabling investors to acquire, restructure and grow their mid-market portfolio companies.

Inherent in ABL is flexibility and ABL providers have built a reputation for speed and certainty of execution. As awareness of that has grown within the private equity sponsor community, it has transitioned from a peripheral solution to a primary first-call partner. Consequently, private equity and ABL now collaborate effectively on myriad event-driven transactions – management buy-outs and buy-ins, bolt-on acquisitions, carve-outs and executing buy-and-build strategies, as well as securing growth capital.

The transformation of ABL from its initial debenture-driven ‘invoice discounting plus’ proposition to a more sophisticated targeted funding model has been something of a game changer. It utilises loan-to-value ratios against specific assets. ABL facilities grow with the business, therefore offering flexible and scalable financing structures, maximising transactional headroom and boosting growth across the business cycle, from acquisition through to exit.

Portfolio company demand

In recent years, ABL has gained a significant amount of traction among private equity-backed portfolio companies. For us at Arbuthnot Commercial Asset Based Lending, such portfolio company transactions comprise more than half of our ABL transactions and I expect this trend to continue, especially as other lending options become more restricted.

As we have seen many times before, liquidity issues tend to hit the high street first. ABL’s ability to leverage balance-sheet assets provides a stable foundation for transactional funding in uncertain times. 

Facilities are typically covenant-light, giving portfolio businesses greater financial freedom. ABL also ensures swift access to capital within tight timeframes, meeting the demands of vendors and acquirers.

Private equity entered 2024 with a record $2.67tn in dry powder globally; buoyed by stabilised interest rates, the opportunities for businesses seeking growth capital are significant. But private equity will always need some form of leverage in a deal.

Building blocks

We are witnessing a wave of consolidation as private equity firms bolt on synergistic acquisitions to platform portfolio businesses. ABL provides the necessary working capital to fund each acquisition, allowing the platform company to pursue multiple opportunities. By leveraging the target business’s assets as collateral, ABL enables the platform company to access financing without diluting equity or relying solely on cash reserves.

In the past year, the widening valuation gap between vendor expectations and buyer appetite emerged as a significant obstacle to dealmaking. To address this challenge, flexible deal structures are gaining greater prominence. Vendors are increasingly receptive to deferred performance-based earnouts, enabling them to exit while retaining a stake in the future success of the business.

With competitive demand and supply tension an increasing feature of the current market, timing is critical. Speed has therefore become an even more decisive factor in dealmaking. But it is still important to engage with asset-based lenders early on in the process.

A typical ABL-provider due diligence process includes an on-site survey of the debtor book and related financial information, plus valuations of the assets to be financed. It should be expected to take one to three weeks depending on the complexity of the business and location of assets.

Private equity and ABL providers frequently work collaboratively to structure bespoke funding solutions, where the total quantum of capital deployment and speed of delivery are critical to deal execution. One relatively recent innovation is the integration of ABL with cash-flow loans creating hybrid funding structures.

This model delivers an optimal injection of cash to support the purchase consideration of the target business, complementing equity contributions and other sources of debt. Post-transaction, ABL offers a revolving line of credit to fund the business’s growth strategy. It also enables the optimisation of capital structures, which in theory should enhance financial performance and ultimately increase shareholder value. This combination offers a more comprehensive financing solution that addresses both immediate transactional needs and longer-term operational requirements.

Private equity firms principally use ABL as a flexible financing component for event-driven transactions such as management buy-outs and buy-ins, acquisitions and corporate carve-outs. ABL can deliver the necessary working capital to support the purchase and day-to-day working capital of the acquired company, while private equity provides capital and expertise for growth or restructuring. This allows the private equity firm to maximise its returns by using leverage while minimising the risk.

In scenarios where a portfolio company requires capital to fuel growth, such as expansion into new markets, product development or marketing, private equity can invest securely in the knowledge that ABL will offer maximum liquidity against the company’s assets. This allows the portfolio company to access the necessary funds to pursue growth opportunities without diluting ownership excessively.

The ever-closer alignment between private equity and ABL, coupled with the push for sector consolidation, in no small part driven by longer hold periods, as well as pent-up vendor demand among retiring baby boomers, will drive M&A in the future. I think ABL will increasingly help leverage those private equity transactions.