Monetizing passive assets: Unlocking the billion treasure chest
The limitations of traditional debt financing and the consequential effects of corporates over-leveraging have become more apparent since the macroeconomic contraction emerged last quarter of 2015. Currency depreciation coupled with FX volatility and tight liquidity sent most corporates spiraling towards huge losses and even potential insolvency and this apparent credit constraint has become the new normal for Nigerian corporates and SMEs operating in the current environment.
Obviously, traditional bank finance will always remain a significant financing source, however, the current situation does inform the need to broaden the range of financing instruments available to corporates and entrepreneurs for the purposes of improving access to credit to meet their cashflow, capex and investment growth objectives.
Therefore, there is an apparent imperative for a change in narrative and shift in focus to those alternative financing structures and options that could potentially unlock significant value to businesses and lead to exponential balance sheet growth and profitability.
It is incontrovertible that internal cashflows are not enough to fund investments and leverage is at all time high that is unsustainable hence the question then is how do firms ensure they meet their funding needs without breaking their gearing ratios while still achieving their growth ambitions? While there are undoubtedly many alternative financing options, one that is often times overlooked is asset based financing.
The billion treasure chest
There has always been a positive correlation between asset tangibility and capital structure of firms but that relationship has been largely one sided on the side of tangible assets based on their perceived limited utility here in Nigeria. Generally, firms with tangible assets tend to have more leverage largely because tangible assets constitutes suitable collateral. Typically, in the traditional lending relationship in Nigeria, the credit and risk assessment of the borrower is fundamentally based on the tangibility and securitability of its assets consequently the focus on the assets is more from a collateralization perspective rather than a financing one.
Most Nigerian firms have a strong focus on asset acquisition and diversification hence own a variety of assets such as real estate, plant & equipment, inventories, marketable securities, account receivables etc and have significant asset bases. Taking a closer look, what is both surprising and revealing is that the book value of these assets are in most cases more than three times the accumulated debt i.e. the assets as a percentage of debt is still significantly high.
It is therefore increasingly obvious that the focus of firms should be on asset utilization and optimization rather than on asset acquisition. Understanding the how and when to monetize these assets will not only unlock and unearth a profound source of financing for firms but could also significantly alter the way firms view these assets on their balance sheet.
The obvious question then is how to monetize these passive assets? but first it is necessary to identify these treasure gems.
3 gems from thetreasure chest
• Intangible Assets: These can be spilt into two distinct categories – intellectual based intangible assets such as Goodwill, patented designs & technology, trademarks, trade secrets, royalty, data base etc; and transactional based intangible assets such as account receivables, marketable securities. Granted, intangible assets tend to be more difficult to identify, separate, utilize and value – with their value being more sensitive to who owns and employs them – they do however hold ground breaking potential as a source of financing.
In the past, businesses primarily invested in the tangible means of production and the value of firms were at least somewhat related to the value of its physical assets. But now with the growth of technology, media, and entertainment it is becoming apparent that the economy is fundamentally shifting towards a knowledge based economy like most western economies already have; and the importance of intellectual based intangibles could become unquantifiable. On the other hand, transactional based intangible assets remain a veritable source of working capital financing given their relative liquidity.
• Surplus Assets: There seems to be a cultural proclivity towards non-strategic asset acquisition by Nigerian firms hence chances are these bloated assets are not being efficiently optimized to their true potential. It seems that the rationale driving the asset surplusage by these firms is connected to traditional lending perspective that views assets more from a collateral standpoint and less from a financing one. Quite a significant amount of untapped capital is inherent in the asset category which if appropriately aggregated and exploited could unlock a significant source of liquidity for firms.
Non-core Assets: These are assets that are not core to the operations and business activities of the firm hence more often than not play passive roles on the balance sheet. They do vary from firm to firm and their value and the extent of utilization may depend on a number of factors such as nature of the business, investment strategy, long term business objectives etc but what is undeniable is that this category of assets could be better utilized in the financing needs of the firm.
Understanding the how
Clearly there is a need for an alternative to traditional debt in order to prevent firms from debt overhang therefore firms require financing options that can sustain their short and medium-to-long term financing needs but that rely on a different mechanism than traditional debt hence asset based financing. The underlying principle of asset based financing is that the firm obtains financing not based on its credit standing, but on the value a particular asset generates in the course of business.
It is fundamentally looking beyond the liquidation value of an asset and more its inherent capital value. The close relationship between the liquidation value of an asset and the amount borrowed, as well as the broad range of assets that can be used to access lending, are the key factors that distinguish asset based financing from traditional secured lending in which the loan amount and conditions depend on the overall assessment of the firms’ credit worthiness.
The key advantage of asset-based financing is that firms that lack credit history or face temporary shortfalls or that need to accelerate cashflow to seize growth opportunities, can access working capital in a relatively short time.
Below are the types of asset -based financing.
• Asset-Based Lending (ABL): A structured lending arrangement in which the financier focuses on a sub-set of the firm’s assets as the primary source of repayment of the facilities. Under this arrangement the revenue generating potential of the asset is equally as important as the liquidation value of the asset hence the facility amount is heavily contingent on the appraised value of the assets which comprise largely of account receivables, equipment, real property, and inventory. Granted this form of lending is associated with risk such as risk of value dilution of the assets, or protracted delays in liquidating the asset however to mitigate these risks most asset based lending is often at a discount and is based on quality assets.
ABL can serve the needs of firms that are at growth stage or that face seasonal build-up of inventory and receivables, whose value can hardly be reflected in traditional debt financing.
• Factoring: This represents a viable substitute for collateralized lending and can be termed as supplier short term financing. Under this arrangement, firms sell their credit-worthy account receivables at a discount in exchange for immediate cash hence the factor (ie buyer of the receivable) assumes both the title to the asset and the default risk under the account receivable. Also, the factored assets (ie the account receivables) no longer forms part of the estate of the seller (where the transaction is done on a non-recourse basis though it may be structured on a recourse basis). Two essential features that differentiates Factoring from ABL is that the former (a) exclusively involves the financing of account receivables rather than a broad range of assets; and (b) is actually a bundle of complementary services involving a credit and collections component.
Most interestingly, factoring though a source of working capital is not a loan and there are no additional liabilities on the firms’ balance. As a source of working capital finance, factoring is particularly useful for informationally transparent firms with a solid base of customers and high investment in intangible assets.
• Warehouse Receipts: This form of asset based financing is best suited for commodity producers and traders and is essentially based on the quantity, quality and merchantability of the commodities itself. Under this arrangement, producers/traders deposit commodities in a warehouse and a receipt which evidences possession. This receipt can then be used by the depositor to obtain financing against the commodities which is evidenced by the receipt.
This form of financing is very apt for traders that lack credit history or other collateral to access financing hence particularly suited for producers and traders of agricultural commodities.
• Leasing: A way a company can finance the purchase of an asset, instead of borrowing and using the new asset to provide security for the loan, is by leasing. In a lease contract no or limited up-front cash down-payment or security is required hence leasing can finance a higher percentage of the capital cost of an equipment thereby allowing the business entity to preserve cash resources or existing banking facilities to meet working capital needs.
Despite their obvious source of value, only few firms will be able to deploy this alternative financing arsenal or maximize value from their assets because of the complex set of interwound challenges below:
Knowing the Real Value of What You Own: As earlier stated the underlying strategic reason for retention of certain assets is purely from a collateral perspective. This conservative approach pays little or no attention to maximizing the ROA of the Firm. A full knowledge of what you own and its true potential is the first most important step in developing a robust asset optimization strategy.
Limited Market Awareness & Acceptance: There are both a limited number of market participants and market products that are targeted at these alternative financing options and even those are few and far between. Several reasons abound as to why this is so, however, inadequate information, dearth of innovation and narrow perception of risk on the part of the market definitely are central to the limited awareness and acceptance.
Information Asymmetry: The informational opacity and weak information infrastructure about SMEs and Corporates in Nigeria is a serious impediment to utilizing some of these asset based financing options. Without fixing the general lack of data on payment performance and access to commercial credit information that helps in assessing credit risk, applying these options will continue to remain a mirage.
Legal & Regulatory Challenges: Specific legislation recognizing some of the options, lack of good secured lending laws, weak contract enforcement environment and inefficient judicial system are just some of the hurdles under this heading that plague the development and acceptance of these options within our jurisdiction.
Across the range of options analyzed, it is clear that there are challenges, however, it is also incontrovertible that for SME and Corporate firms to grow they require a more diversified funding pool and this can only be achieved not only improving the knowledge and understanding about these alternative sources but more importantly by supporting these economic actors with robust legislation that support these options and drive innovation, having stronger contract enforcement regimes in place and financial institutions rethinking their assessment of risk.
Abayomi Adebanjo, is a Managing Associate in Jackson, Etti & Edu and holds a MBA from the prestigious Lagos Business School and certifications from London School of Economics and St Catherine College, Oxford University
Big Read |