In a loan agreement for an asset-based lending (ABL) facility, the lenders will be focused on the value of the company’s assets that are being used as collateral to secure the loan. The borrowing base is a formula found in asset-based loan agreements that establishes the maximum amount that the borrower can borrow. The definition of borrowing base is heavily negotiated in an ABL loan. Specifically, the parties will be focused on which types of assets should be included and excluded from the borrowing base definition.

Typical assets included in the borrowing base formula include receivables, inventory, and equipment. Receivables are the most common type of asset to support loans in ABL facilities. It is rare for just equipment to support loans in ABL facilities. A valuation must be assigned to each of the assets included in the borrowing base. For assets involving complex valuations, such as certain types of equipment, an independent appraisal may be necessary.

The lenders will request that poor quality assets or assets that would be difficult to sell in a foreclosure sale to be excluded from the borrowing base. The eligibility criteria for whether certain assets should be included in the borrowing base requires a degree of business judgment by the lenders.

Since the valuation of the borrower’s asset may fluctuate over time, the borrowing base amount is determined at a given point in time. The loan agreement will generally require the borrower to provide periodic reports to the lenders with an updated borrowing base calculation. The frequency of the periodic reporting requirements will depend on the types of assets included in the borrowing base. If inventory is a significant component of a company’s total assets included in the borrowing base formula, the company will likely be obligated to provide the lenders with less frequent reports. If receivables make up a significant proportion of the company’s borrowing base, more frequent reports may be required. In additional to ongoing reporting requirements, the lenders will have the right to request an updated borrowing base report whenever the borrower wants to take on new loans or letters of credit.

If the borrowing base amount exceeds the amount of loans that the company has outstanding, the company will not be allowed to take on new loans. The borrowing base amount may inadvertently fall below the amount of loans outstanding due to declines in the value of the company’s assets. This is known as having over-advances. In some cases, such over-advances may be acceptable for a limited period of time to provide the business with operational flexibility.

The lender may establish reserves against the borrowing base assets. Creating reserves provides the lenders with the ability to reduce the amount the company can borrow while leaving the borrowing base calculation unchanged. For example, it may be useful for the lenders to create reserves against the borrowing base for certain assets that would be difficult to exercise foreclosure remedies over for a temporary period of time.