Table of Contents
- What Is a Delayed Draw Term Loan?
- How Does a Delayed Draw Term Loan Work?
- Key Features of Delayed Draw Term Loans
- Pros and Cons of Delayed Draw Term Loans
- Delayed Draw Term Loan vs Revolving Lines of Credit
- Delayed Draw Term Loan Example Agreement
- Industries That Commonly Use Delayed Draw Term Loans
- Applying for Delayed Draw Term Loans
- What Lenders Evaluate in a DDTL Application
- Alternatives to Delayed Draw Term Loans
- When Are Delayed Draw Term Loans a Good Option?
- FAQ
A delayed draw term loan (DDTL) is a type of business term loan that lets you draw funds several times over the term of the loan. This can be helpful if you plan to expand your business by making multiple acquisitions or capital investments over time. It can also help you handle any unforeseen expenses that crop up in the future.
Delayed draw term loans typically come with strict eligibility requirements and complex loan terms. Read on for a closer look at how these loans work, their pros and cons, plus how they compare to revolving business lines of credit.
Key Points
• Delayed draw term loans allow borrowers to withdraw predefined funds over a set period of time. Unlike traditional small business loans, the entire loan amount is not given to the borrower upfront.
• Delayed draw term loans allow borrowers to save on interest, since interest accrues only on the amount that’s withdrawn as opposed to the entire loan amount.
• Cons of delayed draw term loans include strict eligibility requirements and their use for large loan amounts only.
• Delayed draw term loans differ from business lines of credit in that they are designed for acquisitions, whereas business lines of credit are ideal for short-term financing.
• Alternatives to delayed draw term loans include SBA loans, business lines of credit, and short-term business loans.
What Is a Delayed Draw Term Loan?
A delayed draw term loan allows borrowers to withdraw predefined portions of a total approved loan amount over time, rather than receive the full amount upfront. The withdrawal periods are set in advance and may occur every three, six, nine, or 12 months.
This arrangement enables you to get funds periodically to meet your company’s capital needs — a planned purchase, for example — while paying interest only on the amount you draw.
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How Does a Delayed Draw Term Loan Work?
A delayed draw term loan is structured so that a business can draw funds only on specific dates. In some cases, the lender will have certain conditions your business must meet — such as reaching defined financial goals — in order to be eligible for draws. By the time the loan reaches maturity, the entire loan amount (including interest) must be paid off.
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Key Features of Delayed Draw Term Loans
Delayed draw term loans don’t work like traditional business loans. They have a number of distinctive features, including restricted access to funds, partial interest charges, and loan covenants.
Draw Schedule and Conditions
Unlike a revolving line of credit, DDTL funds are not fully available to the borrower at will. Many DDTL contracts require the borrower to fulfill stated requirements, such as project milestones or financial ratios, in order to access loan money.
Interest Accrual Timing
A delayed term loan typically allows you to pay less in interest compared to a traditional term loan, since you pay interest only on the amount you draw rather than the full principal.
However, these loans often come with fees, including a “ticking fee.” The ticking fee is based on the undrawn portion of the delayed loan and generally grows over time. Once you draw the entire loan amount (or terminate the loan), you no longer have to pay ticking fees.
Covenant Requirements
Loan contracts for DDTLs often contain provisions known as covenants. The lender sets financial and operational rules that the borrower must follow. These rules are meant to lessen the lender’s risk.
Generally there are two types of covenants.
• Affirmative: Obligations the borrower must fulfill, such as locking in enough insurance coverage or abiding by regulations. They may take the form of financial metrics (e.g., maintaining a certain debt-to-equity ratio) or reporting requirements.
• Negative: Actions the borrower must avoid. Examples might include changing the company’s ownership structure, selling certain assets, or taking on additional debt.
Pros and Cons of Delayed Draw Term Loans
As with all types of small business loans, delayed term loans come with both benefits and drawbacks. Here’s how they stack up.
| Pros | Cons |
|---|---|
| May cost less in interest | Strict eligibility requirements |
| Offers withdrawal flexibility | Only available for large loans |
| Can access funds quickly | Terms can be complicated |
Delayed Draw Term Loan vs Revolving Lines of Credit
Both delayed draw term loans and revolving lines of credit are flexible forms of financing. Both allow you to use the funds when you need them and only pay interest on the amount you draw. However, there are some key differences between these loan products.
For one, delayed draw term loans are generally harder to qualify for than business credit lines. In addition, they usually have more complicated loan terms and conditions.
Another distinction is that revolving credit is designed for short-term capital needs like working capital, not for acquisitions. Delayed draw term loans, on the other hand, are considered long-term loans and are often used for acquisitions.
And, while revolving credit allows you to draw funds, repay those funds, and draw them again, delayed draw term loans do not. Once the delayed draw term loan is repaid, the funds are no longer available for use.
| Delayed Draw Term Loan | Revolving Credit | |
| Interest | Lower | Higher |
| Flexibility | Less | More |
| Do funds renew? | No | Yes |
| Can they be used for acquisitions? | Yes | No |
| Qualifying | Harder | Easier |
| Rules | Simple | Complicated |
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Delayed Draw Term Loan Example Agreement
As an example of a delayed draw term loan, let’s take a computer software company that is looking to borrow money to expand its product line. A lender agrees to give them a $5 million loan with a five-year term. However, since the technology is constantly evolving, the company heads decide they would rather not make a large, one-time acquisition but, rather, several smaller acquisitions over time.
Instead of a traditional term loan, they negotiate a delayed draw term loan that allows them to access $1 million every year, as opposed to $5 million all at once. This allows them to take advantage of purchase opportunities as they come up and pay less total interest over the life of the loan.
Industries That Commonly Use Delayed Draw Term Loans
Businesses that need committed yet flexible financing for long-term, large-scale transactions may want to explore DDTLs.
Industries that frequently use DDTLs include:
• Construction and real estate. Companies use these loans to manage project financing, drawing funds as different phases of construction conclude.
• Healthcare and biotech. Some pharmaceutical companies have used DDTLs to back expansion deals.
• Manufacturing. DDTLs can help these businesses buy capital assets or expand operations.
Applying for Delayed Draw Term Loans
Generally, delayed draw term loans are only offered to businesses with high credit scores that are interested in getting a large term loan to finance future acquisitions or expansion.
If you’re interested and think you might qualify, applying for a delayed draw term loan is similar to applying for any business loan. You’ll likely need to provide basic information about your business, your company’s financial statements, information about yourself and any other owners, and information about collateral, if required.
If you suspect your documentation won’t satisfy a traditional lender, you may want to explore a stated income business loan from online lenders. That process is often more flexible.
What Lenders Evaluate in a DDTL Application
As noted above, the process of getting a DDTL is similar to that for standard business loans. Lenders generally want to see a strong credit history, stable cash flow, and a solid business plan. They will also want documentation like financial statements, market research, financial projections, balance sheets, income statements, and tax returns. They may want collateral in order to lower their risk.
DDTL lenders in particular could focus on the specific ways your business will use the funds, along with appropriate conditions for future draws.
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Alternatives to Delayed Draw Term Loans
Delayed draw term loans are one of many types of business loans that can help you grow your business. Here’s a look at some other options.
SBA Loan
Because SBA loans are partially guaranteed by the U.S. Small Business Administration (SBA), they represent less risk to lenders than other types of small business loans. As a result, SBA loans generally offer large loan amounts and attractive rates and terms. With an SBA 7(a) loan, for example, eligible businesses can borrow up to $5 million for a range of business purposes.
Term Loan
A traditional term loan is a small business loan in which you receive a lump sum of capital upfront, then pay it back (plus interest) in regular installments over the term of the loan. Term loans are offered by banks, credit unions, and online lenders. The funds can typically be used for any business purpose. Repayment terms are usually up to 10 years but may be longer.
Short-Term Loan
If you need access to cash quickly, you might consider a short-term business loan. These loans are typically easier to qualify for than traditional term loans and can be used for virtually any business purpose. Repayment periods are often between three and 18 months. With some online lenders, qualifying businesses might be able to access funding in as little as one day.
Business Lines of Credit
A business line of credit is a form of revolving credit. You receive access to a set credit limit and, unlike with a DDTL line, can access the funds you want (up to that limit) whenever you want them. Like with a DDTL line, though, you pay interest only on what you borrow. As you repay the money you owe, you can access that money again throughout the draw period. Once the draw period ends, you can no longer access the credit line. At that point, the repayment period begins.
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When Are Delayed Draw Term Loans a Good Option?
A delayed draw term loan can be a good option if:
• Your business has strong credit.
• You need a large loan to expand your business.
• You want to make several acquisitions or capital investments over time.
Unlike with a traditional term loan, you won’t have to pay interest on the full loan amount. You’ll only pay interest on the portion that you draw.
The Takeaway
Delayed draw term loans allow borrowers to withdraw preset portions of their approved loan amount over time. Only the withdrawn funds are subject to interest, which can help lower the borrower’s costs. DDTL amounts tend to be large and their rules can be complex, so these loans are typically used by established companies for big moves like expansions or acquisitions.
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FAQ
What are ticking fees on delayed draw term loans?
Ticking fees on delayed draw term loans are fees that accrue on the undrawn amount of the delayed loan. Once you draw the entire loan amount (or terminate the loan), you no longer have to pay ticking fees.
What is delayed drawdown?
A delayed drawdown occurs when a borrower doesn’t receive all the proceeds of a term loan upfront. With a delayed draw term loan, a borrower receives a certain portion of the loan at set intervals, which may be every three, six, nine, or 12 months.
Do delayed draw term loans amortize?
Some delayed draw term loans amortize, but it depends on the lender and the terms of the loan.
Are delayed draw term loans considered secured or unsecured?
Delayed draw term loans are often secured by collateral such as the borrower’s real estate or business assets.
Can startups qualify for a delayed draw term loan?
Startups can qualify for DDTLs but could face headwinds if they’re still evolving. Lenders generally look for strong credit history, stable cash flow, a solid business plan, and many financial documents including balance sheets, income statements, and tax returns.
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