Are you a small business owner? If you are, or you’re considering becoming one, you’re in great company. There are 30.2 million proud small business owners in the U.S.
That’s 99.9% of businesses in the country!
As a small business owner, you know that hard work and innovation are pivotal to success. But so is focusing on the financial logistics. To start and sustain your small business dreams, you need funding.
Are you considering what kind of loan is best for your business? Are you wondering whether you qualify for a loan? Curious about what a borrowing base is?
It’s just one of the important concepts you’ll want to know before you sit down with a potential lender. Keep reading to learn about or brush up on some borrowing base basics.
Understanding Asset-Based Lending
Even if you’re not a financing newbie, the world of business loans can be plain confusing. But there’s no reason to be intimidated—especially when you arm yourself with helpful information.
But before you dive into what a borrowing base is, it’s helpful to understand what asset-based lending is all about.
What’s an Asset Exactly?
An asset is anything that holds financial value to your business. If it’s not of economic gain in the short term, it will be in the future.
There are a few types of business assets to know: short-term, fixed, financial, and intangible.
Short-term assets describe items that you expect to turn into cash within the short term. That could include the cash you have, inventory, as well as accounts receivable.
Fixed assets are the opposite. They’re the type of resources that you use over an extended period of time. Examples include building facilities and equipment.
Financial assets apply to various investments such as stocks and securities.
Intangible assets are appropriately named. They describe items like patents and copyrights. You can’t touch them, but they’re of financial value.
Types of Asset-Based Loans
An asset-based loan is a type of financing your company receives based on your assets.
Most commonly it’s a line of credit that a lender gives your business. It could also be structured as a loan. If you receive a credit line, the amount you can borrow depends on the value of your collateral.
Who Benefits from Asset-Based Loans?
Who are asset-based loans good for? You guessed it: companies and small businesses.
Cash flow is often a top priority for small businesses, especially young ones. You may need this type of assistance to cover operating costs, purchase equipment, cover payroll, and grow.
These loans can offer a helping hand to small and midsize businesses that need cash immediately. They can also be helpful if you haven’t been in business long and don’t have years of revenue to show.
Asset-Based Lending Vs. Traditional Lending
At this point, you may be wondering what makes asset-based loans different from traditional ones.
A traditional business loan focuses much more on the borrower. A lender will be mindful of your personal cash flow and credit score, which should be excellent. You’ll also have to show that your business is established and profitable.
Asset-based loans revolve around, well, your assets. A lender will care more about the quality of the collateral you can offer, and not performance. This means this type of financing can offer flexibility for a wider variety of small businesses.
Borrowing Base Definition
A borrowing base is a central part of asset-based lending.
It’s the amount of money a lender will loan your company based on the value of your business assets. The amount of collateral you offer in order to secure the loan influences just how much a lender is willing to give you.
In other words, the borrowing base is how much money your business can actually borrow if and when it needs to.
This process is similar to the way that aspiring homeowners apply for home loan pre-qualification.
You submit a detailed account of your assets and income to a lender. If you pre-qualify for a home loan, a lender can offer an idea about how much you can actually borrow.
The Importance of Collateral for Calculating Borrowing Base
By now you know that collateral plays a crucial role in the borrowing base equation. What exactly qualifies as collateral?
Collateral is any asset that you offer up to a lender in order to receive a loan. It’s a way of signaling to the lender that you intend to make payments on time. If you’re unable to pay on time, however, the lender can take this asset from you.
For small businesses seeking loans, collateral to set a borrowing base may include:
- Accounts receivable
- Fixed assets
Usually accounts payable and inventory are the primary assets used as collateral for this type of borrowing. But your collateral could be a mix of tangible resources like inventory and property. It depends on the type of business you run.
The bottom line is that asset-based lending is all about collateral. Your collateral helps you secure this type of loan.
And it also helps to determine how much a lender will give your business, based on the borrowing base calculation.
How to Calculate It
If you’d like to determine your business’ borrowing base, first figure out the value of your collateral.
You can do that in a few different ways.
- Calculate the value of your entire inventory based on its market value
- Do a throughout assessment of your equipment value—with depreciation
- Tally up your accounts receivable for balances due within 30-90 days
The collateral amount is just one of the important parts of the borrowing base calculation. You also need to know the discount factor.
The discount factor is a percentage of what a lender will give you based on the value of your collateral. This percentage is influenced by what the lender considers your weaknesses and strengths—and the risk level involved in lending to you.
Lenders calculate the discount factor in different ways. It’s wise to inquire about those details with your lender.
Your particular lender could set your borrowing base based on the type of asset you offer up.
Let’s say your promised collateral is made up of accounts receivable and inventory. Your lender may only allow you to borrow against 50% of your inventory collateral. At the same time, you could receive up to 75% on accounts receivable.
Crunching the Numbers
There are a few approaches to computing a borrowing base. The most common method involves the lender deciding on a discount factor. Then they will multiply that by the value of your collateral.
The resulting figure is your borrowing base.
How does this look in action?
Say your company applies for a line of credit. You present $100,000 worth of collateral in inventory and accounts receivable.
Based on what you offer up in collateral and the lender’s evaluation of your assets, they determine that your discount factor is 70%.
The lender multiplies the discount factor against your collateral. As a result, you are eligible to borrow 70% of your collateral. This means that the most amount of money the lender will give you is $70,000.
Borrowing Base Monitoring
In order for a lender to calculate the borrowing base, you may be asked to supply detailed, official information. Some lenders will request a borrowing base certificate (BBC).
If you’ve already done the work on your own to value your collateral, you’ll be in good shape.
While the BBC will vary depending on your lender, expect to provide information about:
- Assets for collateral use
- Sales data
- Inventory assessments
- Accounts receivable
A BBC isn’t a one-time document. You may be asked to complete this certificate on a regular basis.
Your lender may require a monthly update. In other instances, your bank may ask for bi-annual or quarterly checks.
In some cases, your lender may send someone to your business for monitoring. An investigator could pop in to periodically to appraise your assets and make updates to your BBC.
It’s your responsibility to verify the availability of the collateral you promised the lender. If there are changes, you should account for them. You do not want to violate the terms of your financing agreement.
Why Lenders Prefer to Use It
What is the big fuss about using a borrowing base? Why do lenders like them? In a word, security.
In fact, asset-based loans are commonly referred to as secured loans. Collateral serves as that security for the lender. Loans that don’t require collateral are called unsecured.
It makes sense. When a lender uses a borrowing base as a benchmark, they’re protected by actual assets. If you fail to pay, lenders can still get their money.
They can seize your assets. This helps them recoup any losses if you default on payments.
If your collateral value decreases, then your credit line also declines. This is another protective measure for the lender.
And if the value of your collateral increases, your credit line may increase too. But since a borrowing base has been set, there’s a cap on that amount. This also provides a safeguard for your lender.
How Does Borrowing Base Impact Borrowers?
It’s easy to understand why lenders like using a borrowing base. They’re protected. But what about borrowers?
As a small business owner, you might be thinking that it’s risky to put your assets on the line.
But this could actually serve to help you too.
If you’re not an established company, securing a traditional small business loan can be more of an uphill battle. You don’t have proof of profitability or a long revenue stream. And if your personal credit score is not stellar, that can be one more obstacle.
On the other hand, securing a loan with a borrowing base can be a little easier. A lender will be more focused on your business assets. It won’t matter as much if you’re newer to the game and not yet profitable.
And your personal assets probably won’t be a part of the discussion at all. That means less of a personal risk for you.
Another potential advantage for the borrower? Interest rates on asset-based loans with a borrowing base tend to be lower than unsecured loans.
Deciding on the Right Small Business Loan for You
No small business has the exact same financing needs. Luckily, you have options when it comes to the type of loan you pursue.
Even if your business is fairly new, you can find the flexible loan you need to progress to the next level.
We offer financing solutions for small businesses in a range of industries.
If you work in the e-commerce or retail space, we understand the challenges you face.
You need cash, room to grow, and we can offer that. A term loan could help you tackle a single expense like a website project. An inventory line of credit could help you pay your suppliers or cover operating costs.
Technology companies turn to us for term loans that can help them hire new employees, expand, and make software investments.
Restaurants partner with us to help them expand their facilities with an expansion loan. We also help with equipment upgrades through equipment loans.
We work to support small businesses that are involved in franchising, home healthcare, and commercial cleaning, just to name a few. And we’re always open to expanding to other industries as well.
Take the Next Step for Your Small Business
If you’re not sure which small business loan approach is right for your company, you don’t have to wander alone.
We know how challenging the process can be with a traditional bank. There’s an 80% rejection rate for small business loan applications. But it doesn’t have to be a losing battle.
Whether you’re looking for an accounts receivable line of credit, term loan, or simply need advice about your borrowing base, we’re here to help.
Are you ready to find the right loan for your small business? Apply today to see if you qualify for one of our customizable small business loans.