Before You Sign an Asset-Based Loan

Asset-based lending can be a powerful way to finance a growing CPG company. It can also create a false sense of security because the number at the top of the term sheet is not the same as cash the company can actually use.

The founder is not choosing only an interest rate. The founder is deciding how much reporting, collateral control, refinancing risk, and lender discretion the company can safely accept in exchange for liquidity.

A $3.5 million revolver that is fully drawn is not $3.5 million of liquidity. It is $3.5 million of debt. Additional availability depends on eligible receivables, eligible inventory, advance rates, reserves, concentration rules, reporting, covenants, and the lender's contractual control rights.

I have managed this from the borrower side: a working-capital revolver that grew from $2 million to $3.5 million, two term loans and roughly $6 million of total debt with a large regional bank. That meant borrowing-base calculations, covenant compliance, lender meetings, annual field audits, renewals and searches for alternative financing. The useful lesson is not the history of one facility. It is how quickly a financing tool can become an operating constraint if management understands the headline commitment but not the mechanics underneath it.

Debt may be less dilutive than equity. It is not automatically cheaper, and the interest rate is not the only price.

A revolving line is a formula, not a cash balance

An asset-based revolver usually advances a percentage of eligible receivables and inventory, subject to caps and exclusions.

Our formula advanced approximately:

• 80% of eligible net accounts receivable within specified aging buckets; and
• 50% of eligible inventory, subject to an inventory sublimit.

The lender did not simply look at the balance-sheet totals. It looked at the collateral that qualified under the credit agreement.

Receivables could become ineligible because of age, disputes, cross-aging, customer concentration, or other contractual exclusions. Inventory could be excluded because it was old, discontinued, unsellable, obsolete packaging, or otherwise difficult to liquidate.

A simplified borrowing base looks like this:

For example, a $100,000 distributor receivable supports $80,000 of borrowing capacity at an 80% advance rate if the entire balance is eligible. If $20,000 is disputed or reserved for deductions, only $80,000 remains eligible and the same invoice supports $64,000. The invoice did not change. The liquidity it supports did.

The distinction between total assets and eligible assets is critical. A company can report rising inventory and receivables while its borrowing base contracts. The lender finances qualifying collateral, not management's view of the opportunity.

Growth can weaken availability

Founders often assume that a large retailer order will improve the financing picture. Sometimes it does. Sometimes the working-capital sequence creates the opposite result.

The company may use cash to buy agricultural raw materials, packaging, and finished goods before the related receivable exists. Inventory eligibility may be capped, haircut, or excluded. Once the product ships, the receivable may qualify, but deductions, disputes, or concentration reserves can reduce the amount the lender will advance.

Customer concentration creates another CPG-specific discussion. UNFI and KeHE may represent a large share of a brand's receivables, but they are distributors serving many underlying retailers. Each year, I had to explain why that concentration did not carry the same commercial risk as selling most of the business to one end retailer.

The lender still has to follow its credit policy and contract. The founder still has to explain the economic reality clearly and provide the data that supports it.

What a borrowing-base audit actually tests

Borrowing-base reporting is not a formality. The lender is testing whether the assets supporting the loan exist, are valued correctly, are collectible or saleable, and comply with the eligibility rules.

Our monthly package included:

• accounts-receivable aging;
• accounts-payable aging;
• inventory valuation reports; and
• the borrowing-base calculation.

Annual field examinations went deeper. Auditors could inspect physical inventory, invoices, proof of shipment, subsequent cash receipts, distributor deductions, cutoff, inventory valuation, obsolete items, and the tie between subsidiary reports and the general ledger.

The work is easier when the company prepares throughout the year. A clean audit package should reconcile each major report, document exclusions, explain concentrations, and identify disputed or slow-moving items before the examiner does.

The CFO should also test the borrowing base internally under downside scenarios. What happens if one large receivable becomes ineligible, a distributor deduction increases, inventory ages past the eligible period, or the lender adds a reserve?

If one adjustment eliminates all availability, the company is operating with less liquidity than management believes. That downside case belongs in the financing decision before the loan closes, not after the lender applies the reserve.

Reporting frequency is a measure of lender confidence

Monthly reporting is common in a stable relationship. A lender may require weekly or even more frequent reporting when risk increases or when the credit agreement already permits tighter monitoring.

That shift changes the finance team's job. The company must produce faster receivable, payable, inventory, and cash information. Forecast assumptions receive more scrutiny. Management has less room to rely on month-end accounting after the operational facts have changed.

Good reporting does not guarantee flexibility, but poor communication almost always reduces it. When the numbers weaken, responsiveness becomes part of the lender's assessment of management.

I treated communication with lenders the same way I treated communication with other critical stakeholders. I picked up the phone, provided the requested information as soon as it was available, and did not disappear when the news was difficult.

Silence causes the lender to assume that management either does not know what is happening or does not want to disclose it. Neither interpretation helps.

Cash dominion changes who controls liquidity

Some asset-based facilities include a controlled account or lockbox structure. Customer receipts flow into an account subject to the lender's control and are swept to reduce the revolver. New borrowing then depends on the updated borrowing base and lender availability.

The operating consequences can be severe if the company has little excess availability:

• customer cash no longer sits freely in the operating account;
• daily or weekly collateral changes affect the amount available to spend;
• the lender may control or approve disbursements under a workout arrangement;
• one large deduction, aging receivable, or inventory reserve can reduce availability quickly; and
• management may need an equity bridge to fund payroll, rent, insurance, or critical suppliers.

These outcomes depend on the loan documents and the company's condition. They should not be discovered during a crisis. If management cannot explain where customer receipts go, when the lender can sweep them, and what must happen before the company can borrow again, management does not yet understand the facility.

Before closing, management and counsel should understand the deposit-account control agreement, sweep mechanics, blocked-account triggers, reserves, default provisions, reporting escalation, and the lender's discretion to change eligibility or availability.

The real cost of debt includes control and refinancing risk

An interest rate is only one part of the financing cost.

Founders should model:

• interest and unused-line fees;
• closing and legal fees;
• field examination and appraisal costs;
• broker fees, if a broker sourced the financing;
• reporting and administrative burden;
• covenant restrictions;
• collateral liens;
• personal guarantees;
• prepayment or termination costs;
• the cost of maintaining required cash-management accounts; and
• the risk that the facility cannot grow with the business.

We spoke with many potential replacement lenders over the years. The recurring challenge was not merely replacing the existing line. It was finding a facility with enough additional capacity to finance expansion. A new lender offering the same ceiling did not solve the underlying problem. Purchase-order financing could address specific orders, but it was expensive and did not always fit the broader need.

Liens also complicate a refinancing or asset transaction. When a lender has a lien on substantially all assets, inventory, receivables, intellectual property, and sale proceeds may all require lender consent or payoff arrangements. A personal guarantee can extend the pressure beyond the company itself.

One lesson I would carry into any future negotiation is to define a path for removing or reducing the personal guarantee after the company establishes a satisfactory track record. A guarantee that was understandable at closing should not automatically remain untouched for years.

Debt versus equity is a control decision

Equity is expensive because the founder gives up ownership in future upside. Debt is expensive when fixed repayment, collateral restrictions, or control rights reduce the company's ability to survive and create that upside.

Debt can be appropriate when:

• the borrowing need is tied to identifiable receivables or inventory;
• margins can support interest and principal;
• collateral turns predictably;
• the company can maintain a meaningful availability cushion;
• downside scenarios do not create an immediate default; and
• the facility grows with realistic business needs.

Equity may be the better answer when:

• the company is funding product development, brand building, or sustained operating losses;
• retail expansion requires more cash than the borrowing base will support;
• the company cannot tolerate mandatory repayment;
• collateral eligibility is volatile;
• a strategic investor adds operating leverage, customer access, or expertise; or
• aggressive debt terms could cause the founder to lose control of the company.

Debt stops being cheaper than equity when its repayment and control terms can cause you to lose the company before the strategy has time to work. Dilution is visible on a capitalization table. Financing risk is often buried in definitions, reserves, control agreements, and default provisions.

Ten questions to ask an asset-based lender

1. Which receivables and inventory categories are eligible, and which are excluded?
2. How are distributor concentration, cross-aging, disputes, and deductions treated?
3. What inventory sublimits and appraisal discounts apply?
4. Can the lender create discretionary reserves, and under what conditions?
5. How often must the company submit a borrowing-base certificate?
6. What events allow the lender to increase reporting frequency?
7. When does cash dominion begin, and can it spring into effect after a trigger?
8. What are the field audit, legal, appraisal, unused-line, exit, and broker costs?
9. What is required to release or reduce a personal guarantee?
10. What happens operationally after an overadvance or covenant breach?

Founders should also ask for a worked example using their own receivables and inventory. A headline facility amount is not enough. Management needs to see expected availability in a normal month, a growth month, and a downside month.

The finance system that protects the relationship

A lender-ready CPG finance function should be able to produce:

• a reconciled borrowing-base calculation;
• AR and AP aging with clear ownership of exceptions;
• inventory by SKU, location, age, and eligibility;
• a weekly 13-week cash forecast;
• distributor deduction and dispute reporting;
• covenant calculations with forward-looking headroom;
• a launch-level working-capital model; and
• a downside plan before a covenant or availability problem occurs.

The right financing partner can help a consumer products company grow much faster than internally generated cash would allow. The relationship is still an environment of pressure. The founder is trading part of the company's financial flexibility for access to capital, whether or not that trade is obvious at closing.

That trade can be rational and valuable. But the financing has to work in the downside month, not only in the base-case model. Founders should understand the borrowing base, reporting burden, cash-control mechanics, guarantee, and exit path in operational detail before the documents are signed.

Author note

Julien Dabi is the founder of Netter Group and a Los Angeles-based fractional CFO. Over 15 years leading finance and operations in CPG, including a decade at Natierra, seven years as CFO, and later serving as CEO, he worked across functional snacks, seasonings, baking products, private label, natural and conventional retail, Amazon, and complex imported-product cash cycles. He now helps founders of growing CPG and consumer-products companies strengthen cash visibility, understand customer and product profitability, and prepare for major retail, financing, and operational decisions.

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