Initial borrowing base: Overview, definition, and example
What is an initial borrowing base?
The initial borrowing base refers to the amount of money a borrower is initially allowed to borrow from a lender, typically determined by the value of the borrower's assets, such as inventory, receivables, or other collateral, that can be used to secure the loan. It is often established in asset-based lending arrangements, where the loan is secured by the borrower’s assets rather than the borrower's creditworthiness alone. The initial borrowing base sets the maximum loan limit that a borrower can access at the beginning of the borrowing period. As the borrower repays the loan or their assets fluctuate in value, the borrowing base may be adjusted accordingly.
Why is an initial borrowing base important?
The initial borrowing base is important because it provides a starting point for the borrower in terms of the credit available to them. It helps both the lender and borrower determine the loan's value relative to the borrower's assets, ensuring that the loan is adequately secured. For the lender, the initial borrowing base helps minimize risk by limiting the loan amount to a percentage of the borrower’s most liquid or stable assets. For the borrower, it provides access to capital while maintaining a healthy collateral-to-loan ratio. Establishing an initial borrowing base also allows for regular reassessments of the borrowing limit, which can change with shifts in the borrower’s financial situation or asset value.
Understanding initial borrowing base through an example
Imagine a company that owns $1 million worth of accounts receivable and $500,000 worth of inventory. The lender agrees to lend the company up to 80% of the value of its accounts receivable and 50% of the value of its inventory. The initial borrowing base is calculated as follows:
- 80% of $1 million (accounts receivable) = $800,000
- 50% of $500,000 (inventory) = $250,000
Thus, the initial borrowing base would be $1,050,000, which represents the maximum amount the company can borrow from the lender at the start of the agreement.
Another example could be a business applying for a revolving credit line secured by its accounts receivable. The lender uses the value of these receivables to establish the borrowing base, ensuring that the line of credit is aligned with the business’s available assets.
An example of an initial borrowing base clause
Here’s how an initial borrowing base clause might appear in a loan agreement:
“The Initial Borrowing Base is hereby established as [insert amount], based on the Borrower’s eligible accounts receivable and inventory, valued in accordance with the Lender’s policies. The Borrower may borrow up to the Initial Borrowing Base, subject to periodic adjustments in accordance with the fluctuations in the Borrower’s assets.”
Conclusion
The initial borrowing base is a critical component of asset-based lending arrangements, providing both the lender and borrower with a clear starting point for the available credit. By linking the loan amount to the value of the borrower’s assets, the initial borrowing base ensures that the loan is adequately secured, helping to mitigate risk for the lender while giving the borrower access to capital. Regular updates and adjustments to the borrowing base can help align the loan with the borrower’s evolving financial situation, ensuring continued access to funds as needed.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.