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If you are evaluating loan options from a bank, you may want to know how term loans differ from other business loans. This article will explain the key terms of a term loan, also called a term facility, by providing an overview of terms common to other kinds of loans and evaluating which terms and conditions are unique.
What Are Term Loans?
A term loan is a bank loan that provides an upfront amount of capital to your business. You must then pay the loan back according to a payment schedule plus interest. Banks usually provide term loans to companies for a specific purpose, such as to acquire a new piece of machinery or another company. This is because the bank expects you will repay the amount over a relatively short period i.e. no more than a few years.
There are several features unique to a term loan, including:
- the set period of the loan;
- a pre-arranged timetable of payments;
- any repayments against the principal that cannot later be redrawn; and
- tranches, each with its own interest rates.
Payment Schedules
The table below explains three common ways you can negotiate the repayment of a term loan.
| Repayment | Description |
| Amortisation | If you repay a term loan through amortisation, you will make payments in equal amounts over regular intervals throughout the loan’s life. Typically, the loan agreement does not require your business to make any payments for a short period after you receive the loan. This is called a payment holiday. For instance, you may have a £1m term loan at 5% per annum to be repaid over a year. The payment schedule might state that you will not make any payments for the first two months. After which, you will then pay £105,000 each month for the next ten months. By the end, your company will have paid off the principal (£1m) plus the interest amount (£50,000). |
| Balloon Repayments | A balloon repayment is where your company does not make any payments until the life of the loan begins to draw to an end. At this point, your company will make increasingly larger payments. Using the same example above, your company might not make any payments for the first eight months of the loan. Afterwards, your business must make incremental payments across the next four months, such as £100,000, £200,000, £350,000 and £400,000. |
| Bullet Payment | A bullet payment is one where you repay the total amount of the term loan at the end of the loan’s life. However, you may make interest payments before then. |
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Common Terms
You will likely find the following terms in your term facility agreement.
Conditions Precedent
Conditions precedent are certain things you or the bank must do before the bank will provide your company with the loan. One typical example of a condition precedent is that you must supply the bank with your company’s constitutional documents and financial records. If you do not provide these documents as a condition precedent, the bank is not obligated to loan your company money.
Interest
A term facility agreement will likely state when your company must make interest payments. Usually, the interest takes the Bank of England’s base rate of 0.25% and then adds a margin. For instance, the rate may be the base rate plus 5%.
The interest term will usually specify interest periods, which may be one month, quarterly, twice yearly, or annually. The date you must make an interest payment will usually be when the period ends or some specified time afterwards.
Fees
Many business loans also contain provisions that entitle the bank to collect a fee for packaging and servicing the loan. The details of this fee, such as if it is a one-off or paid regularly, will be set out in a term of its own.
Repayment, Prepayment, and Cancellation
The facility agreement will usually include one or more terms that specify:
- what date you must repay the principal amount by;
- what conditions your company can repay the amount earlier than scheduled (a ‘prepayment’); and
- when the bank can order prepayments.
Indemnities
Indemnities are terms that obligate you to reimburse the bank for certain expenses incurred under certain circumstances. The facility agreement will specify these circumstances.
For many loans, there is also an indemnity clause for unauthorised prepayments.
Representations and Warranties
Representations and warranties are certain promises you give the bank about your company throughout the loan negotiation process. If the bank later determines that these promises are not kept, you will have breached a term of the loan. In most cases, this is a serious breach and will qualify as an event of default.
Undertakings and Covenants
Undertakings and covenants are terms that codify other sets of promises you give to the bank. These terms outline things your business can and cannot do throughout the life of the loan. Some common examples include:
- not borrowing additional sums of money;
- not granting other security interests in the company’s property; and
- maintaining certain financial performance indicators.
Like representations and warranties, if you breach an undertaking or covenant throughout the loan period, this amounts to an event of default.
Events of Default
Events of default are circumstances that, if they arise, allow the bank to terminate their agreement with you. In practice, this means the bank can:
- demand you repay the outstanding amount and any interest due;
- refuse to provide you with any additional money; and
- enforce their security over your property.
Key Takeaways
A term loan is a bank loan that provides an upfront amount of capital to your business. There are several features unique to a term loan that you should be aware of. These include:
- the set period of the loan;
- a pre-arranged timetable of repayments;
- any repayments against the principal that cannot later be redrawn; and
- tranches, each with its own interest rates.
If you need help understanding your term facility agreement, our experienced business lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. So call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
The main term of a loan agreement is the amount of the loan and the interest your company will pay for it.
If you breach some terms in the loan agreement, the effect might be minor. However, breaching other terms can be quite serious, such as an event of default.
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