Delayed Draw Term Loans: A Complete Guide for Small and Medium Business Owners
Introduction
What is a Delayed Draw Term Loan (DDTL)?
Definition and Overview
Key Features
- Incremental Draws: Borrowers can draw funds in predefined increments during the draw period rather than taking the entire amount at once.
Interest Calculation: Interest is typically charged only on the drawn amount, not the full committed amount, potentially resulting in significant interest cost savings.
Draw Period: The draw period can last from several months to years, depending on the loan terms.
Fees: Lenders may charge fees on the undrawn portion, such as a “ticking fee” that accumulates until the loan is fully drawn or the commitment period expires.
Flexibility: This type of loan allows borrowers to align cash outflows with funding requirements, providing needed capital as financial milestones are reached.
How It Works
To illustrate, consider Omnicom Group Inc., which secured a $600 million DDTL in January 2024 to fund potential acquisitions and strategic investments. This arrangement allowed Omnicom to draw funds incrementally as acquisition opportunities arose, rather than taking the entire loan amount upfront, providing them with the flexibility to react to market conditions (Justia). Large companies commonly use delayed draw term loans to refinance debt as part of completing various transactions, such as purchasing capital assets or making multiple acquisitions.nnSimilarly, private equity firms have leveraged DDTLs as part of their buy-and-build strategies, with draw periods ranging from 12 to 36 months. These firms can acquire smaller companies and gradually expand their portfolios, drawing funds as needed to finance each acquisition (Saratoga Investment Corp).nnUnderstanding the basics of delayed draw term loans helps business owners identify whether this type of financing suits their needs.nn
Differences Between Delayed Draw Term Loans and Other Financing Options
DDTL vs. Revolver
DDTL vs. Traditional Term Loans
Advantages and Disadvantages of Each
Advantages of Delayed Draw Term Loans:
- Greater flexibility and alignment with cash flow needs.
Potentially lower overall interest costs.
Better suited for businesses with staggered funding requirements.
Disadvantages of Delayed Draw Term Loans:
More complex loan agreements and structures.
Requires stronger credit standing.
Advantages of Traditional Term Loans:
Simpler loan terms and structures.
Easier access for businesses with moderate credit profiles.
Disadvantages of Traditional Term Loans:
Higher overall interest costs due to immediate accrual.
Less flexibility in accessing funds as business needs evolve.
Recognizing these differences helps business owners choose the right financing option based on their unique financial situation and growth plans.nn
Benefits of Delayed Draw Term Loans for Small and Medium Businesses
Liquidity Management
Cost Efficiency
Flexibility in Funding
Strategic Financial Management
Potential Risks and Challenges of Delayed Draw Term Loans
Commitment and Ticking Fees
Lender Requirements
Risk of Over-Leverage
Complexity and Accounting Treatment
Application Process for Delayed Draw Term Loans
Eligibility Criteria
- Strong Credit Score: Lenders require a high credit score as an assurance of the borrower’s ability to repay the loan. A good credit history demonstrates responsible credit usage and timely payments.
Adequate Collateral: DDTLs are often secured loans, meaning the borrower must provide collateral like business assets or real estate. The collateral can be seized by the lender if the borrower defaults.
Solid Business Plan: Lenders want to see a viable business model and assurance that the loan proceeds will be used wisely. A detailed business plan containing market research, financial projections, and the intended use of funds is typically required.
Financial Documentation: Borrowers must submit financial statements such as balance sheets, income statements, tax returns, and business credit reports to demonstrate the company’s financial health.
Business Credit Report: Lenders request a business credit report to assess the financial health and creditworthiness of the business, which is essential for meeting the stringent loan qualifying criteria.
High Revenue/Cash Flow: Lenders prefer businesses with strong and stable revenue streams or cash flows to ensure repayment capacity (Saratoga Investment Corp).
Required Documentation
The precise documentation required can vary by lender, but generally includes:nn
- Business financial statements (balance sheets, income statements, etc.)
Personal and business tax returns for the past two to three years
Detailed business plan
Proof of collateral
Personal financial statements of major owners
Credit reports
Steps to Apply
Preparation: Gather all required documentation and ensure your business plan is detailed and comprehensive.
Research Lenders: Evaluate different lenders based on their terms, interest rates, and reputation to find the best fit for your business needs.
Submit Application: Complete the online or paper application form from your selected lender, providing all required documentation.
Review Process: Lenders will review your application, assessing your financial health, business plan, and collateral.
Approval and Draw Period: If approved, discuss and finalize the terms of the loan agreement. Once the agreement is signed, you can begin drawing funds as needed over the term of the loan.
Following these steps ensures a smooth application process and increases the chances of securing a delayed draw term loan.nn