News Column

The role of Asset Refinancing

February 3, 2014

Rushika Bhatia

All too many SMEs in quest of further funding forget the potential value of releasing the cash tied up in company assets which can be a powerful strategy for supercharging liquidity and sourcing valuable development capital. Yet for many top-performing businesses, remortgaging existing assets is standard practice and ensures that maximum value is derived from plant and premises alike. SME Advisor examines this challenging territory and speaks to Abu Dhabi Commercial Bank (ADCB) about the key protocols that asset refinancing will involve. Probably the biggest single reason why Asset Refinancing is not used more widely among SMEs is because it appears to contradict the accepted wisdom that the ownership of assets is a valuable end in itself. After all, we work for a lifetime to pay off the mortgage on our house or apartment, and look forward to the day when we have cleared the last payment on our car finance. Yet ask any management accountant to name the biggest source of waste on the company balance sheet, and the answer will be "assets lying idle". This is especially the case in businesses that have worked towards ownership of large properties warehousing, storage facilities, purpose-built premises, etc. or use high-value plant and machinery with durable life expectancy and re-sale value. Assets of this kind can often be 'remortgaged' to release significant cash sums into the business. Generally, in the SME space, there are three categories of asset that can be considered for asset refinancing. These are - Property Machinery Technology To elaborate, the list of assets that can be refinanced typically include items such as commercial vehicles, engineering machinery, construction equipment, plant, buses and coaches. Often, refinance houses will prefer items that are identifiable with a serial number or registration mark proof of manufacture by a reputable entity and also ensuring that they have an appropriate lifespan ahead of them. Meanwhile, in the Technology sector, it will not only be plant and equipment that can be refinanced, but intellectual and scientific patents and unique processes. However, this type of 'Techno-SME' is relatively rare in the Middle East and GCC, although statistics do show that numbers are beginning to increase. How Asset Refinancing works Asset Refinancing is similar in principle to remortgaging a house, insofar as equity is released against the current value of an item. It can be a good way of injecting cash into a business quickly where money is tied up in assets. It typically involves either 1) Refinancing equipment or vehicles which are owned by a company outright and don't have any existing lien on them. Or - 2) Refinancing assets that are subject to an existing finance agreement. In both cases, you pledge the asset to a lender and repay the facility over a set amount of time with a regular payment. You may want to use the extra capital to reduce your payables or increase inventory, or simply to provide a much needed cashflow boost. The asset is valued by an independent valuation professional, then a loan is granted as a percentage of the valuation. Generally, this ranges from 70 per cent to 100 per cent of asset value (subject to credit). In all cases, the repayment capacity is taken into consideration, when structuring the transaction, especially since some companies looking for a refinancing agreement will be doing so in order to pay existing debts. Moreover, in the case of Point Two, assets can be refinanced to reduce the monthly repayments on an existing finance arrangement, or by spreading repayments over a longer term. Or alternatively, if there is only a relatively small amount of finance left to pay, you can pay off the existing finance completely and use the remainder as sought-after investment capital. Note that in both scenarios, you retain continued use of the asset in question. It's also true that because credit is secured against assets with a resale value, this type of finance can be relatively easy to obtain in comparison to facilities with more detailed application criteria. It's worth mentioning that in environments where there are tax considerations, there are clear tax benefits to asset refinance, as the payments are classed as expenses. So in summary, Asset Refinance can: Boost cashflow by providing an injection of capital into the business. Reduce existing monthly repayments. Raise capital to invest in the purchase of other assets not suitable for standard Asset Finance agreements. The professional view SME Advisor spoke to Martin Roussel Executive Vice President, Head Business Banking Division at ADCB about the role of asset refinancing as a potential tool for boosting business performance and growth. Martin comments that: "While Asset Refinancing can involve many benefits for an SME especially if you are committed to a growth trajectory there are certain considerations which are often overlooked. For example, because you already own the asset, when you apply for finance you are talking about a completely known quantity that should already be helping your business: you can't project new revenue streams or improved efficiency as a result of the asset. Rather, you have to have a thorough business plan in place that demonstrates how you will use and apply the cash sums that the refinancing plan releases. For this reason many banks and finance houses treat Asset Refinancing more like a secured term loan. They'll want to assess the business revenue streams, measure affordability and generally get a picture of the overall health of the business. "I would describe the main advantages and disadvantages of Asset Refinancing as follows. The main advantages are - It provides a simple and cost effective method to release funds from existing balance sheet assets It's a fast method of accessing cash in cases of emergency (although these scenarios cannot be too deep-rooted and seen to impact repayment capacity) or as a method to fund expansion. The business can continue to use the asset without any break. Asset finance is a flexible way to access funds. In the same way as traditional loans, asset refinance agreements can be paid monthly. "However, there are disadvantages, and they include - Asset refinance contracts tend to be rigid, set over a fixed term -although customers can ask for specific terms. Interest rates are generally fixed. Personal guarantees are often required from the businesses owners or directors to secure the asset refinance. "Yet it remains largely true that because we are always talking about a secured loan, the arrangement can be beneficial for those SMEs who are still in the process of building a pristine credit history, for example." Strategies Asset refinancing is a fundamental strategy for SMEs looking for all-out growth, or driven by an ambitiously-structured business plan. Yet in order to be effective and ensure that sums redeemed from assets are used correctly, it requires at least one experienced management accountant to be at the helm of the business. Generally, asset refinancing will be used in scenarios where there is an extremely specific blueprint for using the sums that are released. These will include: Expansion plans into overseas markets. Product R&D and innovation. Upscaling payroll and a commitment to hiring senior and C-level personnel. Structured Mergers & Acquisitions activity. Working capital needs. Increasing property size. As with any business activity that increases the raft of debt, however, Asset Refinancing can only be undertaken with the full agreement of the shareholders. If this is a suitable tactic for your business, it's likely that you are committed to making 2014 a landmark year in the company's evolution and growing commercial status.

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Source: SME Advisor Middle East

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