Borrowing base is a metric determined by the value of assets you have available to pledge as collateral for a loan. It is equivalent to the maximum loan amount a lender will offer based on a given set of assets. The total asset value is multiplied by the lender’s discount rate to determine the borrowing base.
What is a Borrowing Base?
The borrowing base is the maximum amount of money that can be borrowed based on the value of a company’s collateral for invoice factoring. Generally, lenders won’t provide financing equal to 100% of the collateral value, but instead, offer financing based on a discount factor. The value of the collateral multiplied by this discount factor equals the borrowing base, or maximum loan amount.
Essentially, the borrowing base is the biggest loan a lender will approve based on a pre-determined loan-to-value discount rate. For example, if a lender has a discount rate of 20% on accounts receivable, it is willing to lend at 80% loan-to-value. In this case, the advance rate of the loan is 80%, and the discount rate is 20%. A factoring company may disclose either the advance rate, the discount rate, or the loan-to-value threshold.
What is a Borrowing Base Certificate?
A borrowing base certificate is used to list all of your available assets that can be used as collateral for a loan and to determine the borrowing base using the discount rate of the lender. This certificate is the formal calculation the lender uses to determine the maximum loan amount the lender can offer.
Sample Borrowing Base Certificate
Sample Borrowing Base Certificate Image Source: www.publishedguides.ncua.gov
The discount rate a lender applies to asset valuation may vary based on the type of asset being considered. While a lender may require an 80% loan-to-value as a borrowing base for equipment, the lender may only allow a 50% loan-to-value borrowing base for inventory.
Prior to trying to estimate your available borrowing base, you will need to know what discount rate the lender requires. The best way to find the discount rate is to ask your lender.
How to Calculate Borrowing Base
To calculate your potential borrowing base you will need to determine the values of the various assets your business has available. Potential assets that can be used as collateral include inventory, equipment, and accounts receivable. Once you have determined the asset valuation you will apply the discount rate to determine the borrowing base.
The four steps to determine borrowing base are:
1. Determine the Value of Your Inventory
When determining the value of inventory for borrowing base, use the present market value of the inventory. This is the value of the inventory if it were all to be sold today, and not the amount you paid to acquire the inventory. Inventory valuations conducted by the lender may require an on-site inspection.
2. Determine the Value of Your Equipment
The valuation used for equipment should be listed as the current value of the equipment—not the initial retail value. Therefore, it’s important to account for depreciation when determining the current value of any equipment being considered in the borrowing base. A lender will use the depreciated value on any ongoing borrowing base certification.
3. Determine the Value of Your Accounts Receivable
In general, the only accounts receivables that lenders will accept as part of the borrowing base are those that are due in less than 90 days. The value to be included for accounts receivable will be the sum of all eligible invoices.
Lenders may be selective in the invoices they will accept, which may be based in part of the creditworthiness of your customers and whether the invoices are business-to-business, business-to-consumer, or business-to-government. Some lenders are only willing to lend based on specific invoice types (e.g., only lending on B2B invoices).
4. Apply the Discount Rate or Advance Rate
Once you have determined the various values of your assets, you will multiply each type of asset by the applicable discount rate. Keep in mind that lenders may have different discount rates for different asset types. To get the most accurate estimate of borrowing base you will need to be familiar with the various discount rates.
After applying the discount rate to each asset type, you will then add the three figures together to determine the borrowing base. This is the estimated maximum amount that a lender will be able to loan to you based on your current assets. In most cases, the lender will continue to re-verify the value of the pledged assets throughout the course of the loan.
Borrowing Base Monitoring
When a business takes out a loan based on a borrowing base agreement, the lender will usually require you to file an updated borrowing base certificate at regular intervals (e.g., monthly, quarterly, annually). This requirement is to ensure that the business still meets the base requirements for the remaining loan balance.
In the event the collateral value falls below the prescribed borrowing base, the business will need to repay enough of the loan to bring the financing back into compliance. It is your responsibility as the borrower to ensure the updated borrowing base certificates are completed in-full, are accurate, and are provided to the lender on time.
Types of Asset Based Lending
Many types of assets can be used to establish the borrowing base for an asset-based loan; however, there are some assets that are more commonly collateralized. Real estate and equipment are commonly used as collateral; however, inventory, accounts receivable, and other tangible assets can also be used to back small business loans.
The most common types of asset-based loans include:
- Accounts receivable financing: Accounts receivable financing and invoice financing use your current customer invoices to determine the borrowing base for a business line of credit. You select the invoices you want to finance, and the lender advances you the funds less the discount rate (typically 10% to 20%). Some of the best accounts receivable financing companies will advance up to 100% of the invoice value.
- Inventory financing: Inventory financing uses the value of existing or future inventory as the borrowing base for a small business loan or line of credit. Using inventory as collateral is slightly more complicated than using a fixed asset like real estate or equipment because inventory levels fluctuate. Lenders may require you to provide more frequent borrowing base certifications when inventory is used to back financing to ensure that the loan remains properly collateralized.
- Equipment financing: Equipment financing uses the value of equipment you already own or the equipment you are purchasing, to determine the borrowing base for financing. Similar to a personal auto loan, the business equipment protects the lien. In the event you default on the loan, the lender can take possession of the equipment in lieu of repayment on the remaining debt. There will be an ongoing need for borrowing base certification due to equipment depreciation.
- Real estate financing: The equity in real estate you own can be used as the borrowing base to secure a loan. This is typically referred to as a real estate equity loan rather than asset-based financing, though by definition it is a type of asset-based loan. In general, financing based on real estate equity is offered in the form of a line of credit, and most major banks offer commercial real estate equity loans.
- Financing based on other tangible assets: It is possible to use assets other than those named above as part of the borrowing base for a loan, though it is much less common. In general, if you have a tangible asset that has value, and a lender is willing to accept it, you can use it as collateral for a loan. Transactions of this type generally require a professional valuation to determine the value of the item intended to be included in the borrowing base.
Bottom Line
Lenders use borrowing base to determine the maximum loan amount that can be offered to a borrower on an asset-based loan. The borrowing base for each borrower is unique and based on the available assets of the borrower, and the lender’s discount rate or acceptable loan-to-value ratio.
