Lenders size a distributor's line on its collateral, not its earnings: typically 80% to 90% of eligible receivables plus up to 85% of the inventory's net orderly liquidation value, roughly half of cost, usually with a cap on how much of the line inventory can support. Because that collateral grows with sales, the line grows with the business in a way an earnings-based line cannot. What shrinks it: slow-moving stock, goods in transit or at other people's warehouses, customers who pay net of deductions, and suppliers who shorten terms just when volume rises.
- Best fit
- An asset-based line; thin margins make an earnings-based line small
- Receivables
- Typically 80% to 90% of eligible receivables
- Inventory
- Up to 85% of net orderly liquidation value, roughly half of cost, often with a sublimit
- Usually excluded
- Slow-moving stock, most goods in transit, supplier rebates, bill-and-hold sales
- Watch
- Supplier terms, customer deductions and the pre-season inventory build
Why the asset-based line fits a distributor
Distribution runs on thin margins and heavy working capital. A distributor buys finished goods, holds them, sells on terms and collects. Its earnings are modest relative to its sales, but its receivables and inventory are large, liquid and constantly turning over. A lender sizing on earnings sees a small business; a lender sizing on collateral sees a large one.
| Sized on earnings | Sized on collateral | |
|---|---|---|
| What the lender looks at | EBITDA of 1,000 | Receivables of 6,000 and inventory of 7,000 at cost |
| The rule of thumb | Senior cash-flow lenders commonly lend 2x to 3.5x EBITDA | Typically 80% to 90% of eligible receivables; inventory at roughly half of cost |
| After ineligibles | Not applicable | Eligible receivables 5,400; eligible inventory 6,000 at cost |
| Indicative size | 2,000 to 3,500 of total senior debt, shared with any term loan | About 4,590 on receivables (85 per 100) plus about 3,000 on inventory, less reserves and any inventory cap |
| As sales grow | Fixed until earnings are re-tested | Rises with receivables and inventory, up to the commitment |
That is why most distributors of any size end up on an asset-based line, and why the ones with a bank line sized on earnings often find it too small at exactly the moment they grow. The trade-off is reporting: an asset-based lender watches the collateral closely. The comparison is laid out in asset-based vs cash-flow lines, and the choice between bank and non-bank lenders in bank ABL vs non-bank ABL.
Inventory: what counts and what does not
For a manufacturer, the big inventory question is work in process. A distributor has none; its questions are where the stock is, who owns it, and how quickly it sells.
| Inventory | Typical treatment |
|---|---|
| Finished goods in your own warehouse, selling steadily | Eligible, advanced against appraised liquidation value |
| Slow-moving or obsolete stock | Excluded, or reserved against |
| Goods in transit from an overseas supplier | Usually excluded until received; some lenders include them when title has passed and the shipping documents are controlled |
| Stock at a third-party warehouse or logistics provider | Eligible with a letter from the warehouse acknowledging the lender's interest |
| Goods on consignment at customers' sites | Usually excluded |
| Goods held on consignment from a supplier | Excluded: they belong to the supplier |
| Stock a vendor financed with its own purchase-money lien | Excluded unless the vendor's lien is subordinated |
| Private-label goods made for one customer | Reduced value, since only that customer wants them |
| Packaging, supplies, samples and displays | Excluded |
Importers deserve a note. A distributor buying from overseas often pays before the goods arrive, through a deposit or a letter of credit, and waits weeks for them to land. That money is out of the business and, for most lenders, not yet in the borrowing base. Letters of credit can be issued under the line as a sublimit, but each one reduces availability while it is outstanding. See letters of credit under a line and credit facility sublimits.
Turns decide the appraisal
Inventory is advanced against its net orderly liquidation value: what an appraiser thinks the stock would bring in an orderly sale, after the costs of selling it. For a distributor, that number depends on what the goods are and how fast they move. Branded products with broad demand, sold to many customers, appraise well. Perishables, fashion goods, technology that dates quickly and anything with a narrow market appraise poorly.
Owners can influence it. An appraiser and a field examiner will look at inventory by item, with the date each item last sold, and at how many times a year the stock turns. A warehouse carrying a long tail of items that have not sold in many months pulls down the value of everything, both because those items are excluded and because they suggest the purchasing is loose. Clearing dead stock before an appraisal, and keeping a perpetual inventory system that matches physical counts, raises availability more cheaply than any negotiation. More on the mechanics in how lenders advance against inventory.
The field exam will compare your inventory records to a physical count. Differences reduce availability; a clean match is worth more than an argument about advance rates.
Receivables: deductions, rebates and big customers
Distributors sell to retailers, contractors, manufacturers and other distributors, and several of those customer types pay less than the invoice.
- Deductions and chargebacks. Large retail customers deduct for shortages, late delivery, damaged goods, advertising allowances and returns. Every deduction is dilution, and a distributor with a high rate will see a lower advance or a reserve.
- Supplier rebates. Volume rebates due from suppliers sit on the balance sheet as receivables, but lenders almost always exclude them: they are contingent, disputable and owed by the company you buy from, not a customer.
- Contra accounts. A customer that also sells to you can offset what it owes against what you owe it. Lenders exclude the overlap; see contra accounts.
- Bill-and-hold sales, invoiced but still in your warehouse, are usually ineligible as receivables and as inventory.
- Concentration. A distributor with one dominant retailer or contractor customer hits the single-customer cap, commonly 20% to 25% of eligible receivables. See the concentration limit.
- Export sales, which usually count only when backed by credit insurance or a letter of credit; see foreign receivables in a borrowing base.
Receivables more than 90 days past invoice are typically ineligible, as for any borrower; the broader rules are in eligible vs ineligible receivables.
Suppliers and the seasonal buy
The other side of a distributor's working capital is what it owes its suppliers, and it can move faster than anything the lender controls. When a supplier shortens terms, or its trade credit insurer reduces cover on you, the need jumps overnight. A distributor with 3,000 of payables on terms of about sixty days that are cut to thirty has roughly 1,500 more to fund, and no more collateral to fund it with, because the goods on the shelf are the same.
Seasonal distributors face the same squeeze on a calendar. Those that buy ahead of a season, such as building products before spring, heating and cooling equipment before summer, or toys and gifts before the holidays, see inventory peak before receivables do. Because inventory advances at a much lower rate than receivables, availability is weakest just as the need is greatest. Supplier dating programs, which let a distributor take delivery early and pay later, help; so does a seasonal increase in the inventory sublimit or a planned over-advance. See how a seasonal line works and sizing a working capital line.
Covenants and reporting
- A borrowing base certificate weekly or monthly, depending on how heavily the line is used, with a receivables aging and an inventory report by location.
- Field exams and inventory appraisals before closing and periodically after.
- A fixed charge coverage covenant that on many asset-based lines applies only when excess availability falls below a set level. See springing covenants.
- Collections into a controlled account, with the lender sweeping cash against the line either always or only when availability runs low. See cash dominion vs springing dominion.
- Limits on distributions and on other debt, and reserves for rent at leased warehouses, unpaid taxes and anything else that could rank ahead of the lender.
What trips distributors up
- Losing a product line. A distributor's value rests on its supplier agreements. Lenders ask how long they run and whether they are exclusive, and a supplier that could walk away with a large share of sales is a risk they price.
- Vendor liens. A key supplier that filed a lien on the goods it ships, or on everything, has to be subordinated before a line lender will count that stock.
- Margin compression. When suppliers raise prices faster than customers accept them, earnings fall while inventory values rise, and a fixed charge test can trip.
- Dead stock that nobody wants to write down until the appraiser does.
- Merchant cash advances taken to pay a supplier on time, which lien the same collateral the line needs. See refinancing out of merchant cash advances.
- A related importer or sister company that holds inventory or invoices customers, which lenders will want brought into the borrower group or separated cleanly.
Preparing the file
Transparent's line of credit checklist: an AR aging by customer with days outstanding; an AP aging; the balance sheet and P&L; a year-to-date P&L through last month-end; a debt schedule showing existing liens; an inventory report, which for a distributor should show quantity, cost, location and last sale date by item; and, if available, bank statements and two to three years of business tax returns. Add the main supplier agreements and a list of suppliers with their terms.
Transparent builds the full lender package from those documents in a day, charges nothing before a loan closes, and places distributor lines with the 235 lenders in its book that write asset-based loans and lines. Distributors looking at SBA financing for a purchase or real estate can start with the data on SBA loans to industrial supplies wholesalers.
Common questions
- How much of my inventory will a lender lend against?
- Inventory commonly advances at up to 85% of its appraised net orderly liquidation value, which works out to roughly half of cost for many distributors. Slow-moving, in-transit and consigned stock usually counts for nothing, and many lines cap the total inventory can contribute.
- Why does my availability fall before my busy season?
- Because you buy ahead of it. Inventory rises before receivables do, and inventory advances at a much lower rate than receivables, so availability is weakest during the build. A seasonal sublimit increase, supplier dating terms or a planned over-advance can cover it.
- Do supplier rebates count in the borrowing base?
- Almost never. Rebates are contingent on volume, can be disputed and are owed by suppliers rather than customers, so lenders exclude them from eligible receivables.
- Can goods I have paid for but not yet received be financed?
- Most lenders exclude goods in transit until they arrive. Some will include them when title has passed and the shipping documents are under their control, and letters of credit for overseas purchases can be issued under the line as a sublimit.
- Is a bank line or a non-bank asset-based line better for a distributor?
- A bank usually costs less and suits a distributor with steady earnings and clean reporting. A non-bank asset-based lender will usually lend more against the same collateral and tolerate weaker earnings, at a higher price. Which fits depends on the file.