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Understanding the borrowing base can be a challenging task for many businesses.
The truth is, when it’s time to secure funding and grow your business, this concept often becomes the #1 hurdle. Mastering the borrowing base is crucial for accessing various business financing options to scale up smoothly, including equipment refinancing, invoice factoring, and asset-based lending. It’s a fundamental requirement for any company seeking an asset-back lending facility, yet can be a challenge to comprehend. But don’t worry, we’re here to help you understand the borrowing base and how it works. At its heart, the borrowing base is how the loan-to-value (LTV) of the credit facility is calculated. Navigating the complexities of asset-based lending and maintaining an optimized borrowing base can feel overwhelming. But here’s some real talk… Without mastering this aspect of financial management, scaling up won’t happen as smoothly as you’d like.
The borrowing base, in essence, serves as an upper limit on how much capital lenders are willing to extend based on the collateral or value of the collateral, effectively acting as a credit limit. This method safeguards lenders from overexposure while still ensuring borrowers have access to necessary funds, by establishing a credit limit that reflects the value of eligible collateral and any outstanding loans. So yes, understanding its nuances can save startups from potential risks associated with taking on debt. The major question is what is the “collateral value”.
The calculation process for determining a borrowing base is akin to solving an intricate puzzle. It’s about meticulously evaluating different types of collateral, and determining the optimal discounting rates that should be applied. It also involves determining the optimal collateral composition by not overweighting specific assets. To start solving this intricate puzzle, you need to think about what amount eligible collateral is going be included and what is going be excluded. Additionally, the discount factor plays a pivotal role in this calculation process, as it is used to multiply the value of the company's collateral, thereby determining the borrowing base and representing the total amount of money a creditor will lend based on the value of the collateral.
The top of the equation (positive) is really about valuing the collateral - we have two great blogs that go deep into these two items in a lot of detail. The bottom part of the equation (negative) is really determining which things shouldn't be included in the calculation.
Here are some other common items that get added to the borrowing base:
The borrowing base supports trade finance by providing a solid foundation for working capital facilities, enabling businesses to leverage their assets for growth and operational needs.
One issue that does come up with borrowing base calculations is when there are two different currencies represented in the equation, or even there is just money in one currency but it needs to be translated to another currency for purposes of determine if there is a surplus or deficiency (over collateralization). The question is, what FX rate to make the conversion at.
Once the borrowing base has been calculated, you’ll need to multiply it by the advance rate. The advance rate essentially sets the maximum amount that can be borrowed, determined by multiplying the borrowing base by the advance rate, which reflects the loan-to-value (LTV) ratio of the facility. Advance rates come in all shapes and forms (fixed, dynamic, etc.) but for ease of understanding, if a lender gives an 80% advance rate, that means that if the borrowing base is $100, the maximum amount the borrower can actually borrow against that $100 is $80.
In some cases, the lender will include advance rates into the borrowing base calculation itself by further discounting items. If this is the case, the advance rate becomes 100%.
The borrowing amount depends in principle on the advance offered by the borrower. The advance rate represents the maximum share of the current loan amount available to a borrower as a loan.
To measure the collateralization percent or whether there is a deficiency or surplus of financing a debt facility, the equation is typically:
$$(Borrowing Base * Advance Rate) - Current Outstanding Principal$$
Where the current outstanding principal is what has been lent from the lenders to the borrower and hasn't been repaid. Essentially, if the Borrowing Base * Advance Rate is greater than the outstanding principal, your doing well and can borrow more funds. If there is a deficiency, it's important to understand what's driving it. It could be a case of concentration risk or something else that you can talk with your lender about and show how it will be resolved.
When getting a borrower base agreement for an asset, you are likely to need to update the borrower base certificate regularly. It is an important form of documentation that lists applicable property, a price, and shows an advance rate used by the borrower’s calculations. A credit card company might require the use of a certificate indicating the type or amount of collateral you have to borrow from. Collaterals have fluctuating values so it helps make sure your outstanding loans still exceed the limits specified in your original borrowing agreement. Additionally, the borrowing base agreement is a crucial document that outlines the terms for borrowing base monitoring and compliance, ensuring that the value of collateral is periodically reviewed and remains in alignment with the loan agreement.
Technology solutions such as Cascade, help both companies and lenders set borrowing base calculations before a deal is signed, so that the calculations can be tested on real data with real assumptions. This is critical for anyone raising debt that includes a borrowing base calculation, test it and run different scenarios before agreeing to the terms of loan agreement. This often drives legal fees down as many hours are wasted in negotiating borrowing bases through legal documents when they can be negotiated using real data before the lawyers become involved. Once a deal is signed and live, it’s critical for companies to constantly beware of the borrowing base to ensure a deficiency doesn’t occur and if one does occur that it’s resolved quickly. There is no reason the borrowing base cannot be calculated daily (you can read more about the importance of daily calculations here). Furthermore, technology solutions like Cascade facilitate the lending process by making borrowing base calculations more efficient and accurate, ensuring smoother monitoring and management throughout the lending lifecycle.