What it means
A standby line of credit is borrowing capacity arranged to be available if a business needs backup liquidity, rather than for routine daily use, with the limit and conditions agreed with a lender before a cash shock occurs. An undrawn line is not cash in the bank and normally is not outstanding principal debt.
Access can still depend on covenants, eligible collateral and the facility's terms at the time of a draw. Businesses face delayed customer receipts, seasonal demands and unexpected costs, and a standby line can provide time to respond, back a commercial paper programme or reassure stakeholders about available funding.
Check the distinction between committed and uncommitted facilities: a committed lender promises to lend subject to the agreement's conditions for a stated period, while an uncommitted line may be withdrawn or declined more freely. Even a committed line is not unconditional, as a material covenant breach, borrowing-base shortfall or expired facility can restrict a draw, so the borrower should know the notice period and paperwork required to access funds.
A US Securities and Exchange Commission filing for a revolving facility provides a concrete example: it describes a commitment fee on available but undrawn amounts, plus administrative fees and financial covenants. Another filing describes a standby line with drawdowns subject to conditions and a commitment fee paid in shares.
These examples show that fees and conditions vary and that a standby line does not always charge a standard percentage of the full headline limit in cash, so read whether the fee is based on committed, available or unused capacity and how it accrues across days. Suppose a business has a $5,000,000 committed backup line and pays an illustrative annual fee of 0.4% on the entire undrawn amount, so the annual fee is $20,000 while it stays fully unused, excluding other charges.
If part is drawn, the unused-fee base may fall under the contract while interest and borrowing fees arise on the drawn amount. The cash forecast should model both a normal case, in which the business pays the commitment fee without drawing, and a stress case, in which it may need $2,000,000 for several months while customers pay late.
Calculate interest, maturity and any repayment requirement under that scenario, and if the same stress also weakens EBITDA (earnings before interest, tax, depreciation and amortisation) or collateral values, check whether covenants or the borrowing base would still permit the draw. Federal Reserve research notes that contractual terms, including borrowing-base formulas and covenants, can reduce effective availability of a line, so the headline $5,000,000 might overstate accessible cash at the exact moment a business needs it.
Ask the lender for an up-to-date availability certificate or calculation where the agreement requires one, and do not count the full facility as immediate liquidity without testing the conditions. Security and guarantees deserve attention, as a lender may take a charge over assets, require a parent guarantee or restrict other borrowing, which can reduce future financing flexibility.
An owner might prefer a smaller line with lighter security, or more available capacity with stricter terms, depending on the downside case. Compare total costs and rights, not just the commitment fee.
In practice
Real-world examples.
Example
A hotel maintains an undrawn committed facility for a seasonal cash shortfall. It pays a small fee on the unused amount all year and draws only in the quiet months. The finance director repays the draw once the busy season brings in cash.
Example
A borrower checks borrowing-base availability before assuming the full line can be drawn. Eligible receivables turn out to be lower than the headline limit implies, so the usable amount is smaller. The company arranges a second source of funding before the shortfall arrives.
Example
A company budgets both the unused-capacity fee and interest in a stress case. The forecast shows the cost of drawing for several months and whether covenants would still be met. The board approves the facility knowing the full price of the cushion.
Formula
Calculation
Illustrative annual unused fee = eligible undrawn amount x contractual annual fee rate, adjusted for the time outstanding. The fee base and rate vary by contract. At $5,000,000 fully unused and 0.4% for one year, the fee is $20,000 before other fees.
Worked example. The business draws $2,000,000 for six months of the year at an illustrative 8% annual interest rate, and the line is otherwise unused.
- Interest on the draw = $2,000,000 x 8% x 6/12 = $80,000.
- Unused fee while drawn = $3,000,000 x 0.4% x 6/12 = $6,000.
- Unused fee for the other six months = $5,000,000 x 0.4% x 6/12 = $10,000.
- Total cost for the year = $80,000 + $6,000 + $10,000 = $96,000.
The insurance value of the line is the ability to draw the $2,000,000 when needed, which a forecast should test against covenants and the borrowing base.Case study
Seen in the real world.
This illustrative and entirely fictional case follows Desert Resorts, an invented seasonal hotel operator. It arranges a backup facility and rehearses its draw process, including the notice period and paperwork the lender requires. During a later fictional slowdown it draws a permitted amount and adjusts spending. The finance team models the stress case in advance, so the draw covers payroll and supplier payments without surprises. The line bridges a temporary gap, but does not guarantee staffing or solve a permanently weak business model.
Watch out
Common mistakes.
- Treating the entire headline facility as cash that is always available.
- Ignoring covenant, collateral and expiry conditions before a crisis.
- Confusing a standby borrowing line with a standby letter of credit.
Questions
People also ask.
What is a standby line of credit?
A backup borrowing facility the business can draw subject to the agreed conditions.
What does it cost?
It may carry a commitment fee on unused capacity and interest and other fees on drawings.
When should it be arranged?
Ideally before a foreseeable cash shock, while checking costs, conditions and alternatives.
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