Due Diligence Considerations in Accounts Receivable Asset Based Lending

Asset-based lending (ABL) has gained favor in recent years, increasing the opportunity for small or new businesses looking for financing while also raising the level of complexity of the arrangements. Secured by intangible collateral, accounts receivable-based lending raises potential issues that deserve a closer look.

Benefits of accounts receivable lending

ABL based on accounts receivable as collateral can be a suitable option for businesses with a solid customer base and sound business and collection practices. It also offers the lender a liquid asset as collateral. Though it is often discussed in tandem with factoring agreements, A/R lending offers the advantage that the as the lender, you do not need to interact with the borrower’s customers to collect on invoices.

Importance of A/R due diligence

Without physical collateral to inspect, thorough and skilled due diligence is crucial for minimizing risk. Some due diligence considerations inherent in accounts receivable financing include:

• Quality of records – Are the records complete and up-to-date? Incomplete or sloppy records can be a sign of poor business practices or even fraud that would prevent any recovery by the lender.
• Length of time – How long does it normally take the borrowing company to collect on an invoice? Receivables more than 90 days old are ineligible to be included in the borrowing base. If the days sales outstanding (DSO) ratio is high, it could also indicate poor motivation on the part of the company to follow through on collections, a less than ideal customer base, or some other problem that could make the financing a poor investment risk.
• Delinquencies – How many delinquent accounts are there? If these are outsourced to a third party, the information may not be as readily available but are still crucially important to an analysis of the financing risk.
• Signs of fraud – A company may conceal financial problems or misdeeds by shifting payments by applying one payment to another account, sending inflated invoices to skim the excess from the payment sent in, or by creating phony invoices or customers to artificially inflate the value of the collateral.
• Company quality control measures – A borrower that conducts surprise audits or incorporates mandatory job rotation can increase the likelihood that accounts receivable data is reliable.
• Signs of borrower strength – It is important to assess the company’s operating cycle, determine the liquidity of the borrower’s assets, and investigate for red flags such as signs of excessive debt or inconsistent cash flow.

Seasoned lenders counsel in Maryland and Delaware

The lending and banking attorneys at Rosenberg Martin Greenberg are the trusted representatives of top lenders and financial institutions. We listen to the needs of lenders and put our all into perfecting transactions for our clients.

RMG attorneys are experts in the area of asset-based lending and due diligence. Our attorneys know the ins and outs of ABL secured by accounts receivable and other collateral, both intangible and tangible. From the earliest stages through drafting agreements for sophisticated transactions, through enforcement steps if necessary, we use our experience to your advantage at every step.

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