Definition — what a delayed draw term loan (DDTL) is
A delayed draw term loan (DDTL) is a corporate loan facility in which a lender (or a group of lenders) commits a fixed total amount but the borrower can take down (draw) funds in pre‑agreed tranches at future dates instead of all at once. The facility typically sets an availability period and conditions that must be satisfied before each installment is funded.
Why companies use DDTLs (benefits)
– Matches funding to needs: Borrowers access cash only when required (for acquisitions, capital projects, working capital), avoiding interest on unused funds.
– Cash‑flow planning: Scheduled draw dates let management align capital inflows with project milestones or revenue timing.
– Cost control: The borrower reduces immediate total debt and interest expense compared with drawing the full amount up front.
– Lender flexibility: Lenders can control disbursements and include conditions that limit credit exposure until certain criteria are met.
Why lenders use DDTLs
– Risk management: Staged disbursements let underwriters verify covenants and milestones before increasing credit exposure.
– Liquidity planning: A delayed schedule helps lenders manage their own funding and capital allocation.
– Fees and oversight: Lenders typically charge fees on undrawn commitments, providing income while availability remains.
Common parties and contexts
DDTLs are generally used in institutional or syndicated financing (large loans provided by a bank group or agents). They are uncommon in consumer lending. Typical borrowers are companies with established credit histories, though DDTLs also appear in leveraged loan markets where borrowers may have higher leverage.
Key contract elements (terms and covenants defined)
– Availability period: The window during which the borrower may request draws.
– Draw schedule: The number, size, and timing of permitted advances.
– Conditions precedent: Financial or operational milestones (e.g., revenue, earnings targets, minimum cash balance) that must be met for each draw.
– Interest rate and reference rate: Pricing is usually a spread over a market reference rate (e.g., SOFR). Interest accrues only on amounts drawn; undrawn amounts may carry a commitment fee.
– Commitment fee: A fee charged on the undrawn portion while the facility is available.
– Covenants: Financial tests (e.g., leverage ratio, quick ratio)
– Reporting and notice requirements: Borrower obligations to deliver periodic financial statements, compliance certificates, and advance notices for draws. These trigger timing and condition checks by lenders.
– Security and guarantees: Whether the loan is secured by collateral (e.g., receivables, fixed assets) and whether sponsors or affiliates provide guarantees. Security affects recovery rates and pricing.
– Intercreditor provisions: When the DDTL sits alongside other debt (e.g., revolving credit, term loans, bonds), intercreditor agreements allocate priority, payment waterfalls, and enforcement rights.
– Events of default and remedies: Specific defaults (payment default, covenant breach, insolvency) that permit lenders to accelerate the loan, stop further draws, or seize collateral.
– Transferability and assignment: Whether lenders can sell or assign their commitments and on what terms (often subject to pro rata restrictions or borrower consent).
– Governing law and jurisdiction: The legal regime (state or country law) that governs interpretation and enforcement of the agreement.
How DDTLs are used (practical patterns)
– Acquisition financing: A company secures a DDTL to match the timing of a future acquisition payment or earnout.
– Capital expenditure programs: Firms planning multi-stage projects use DDTLs to avoid interest on full amounts before spending begins.
– Working capital backstops: Sponsor-backed companies may use DDTLs as contingent funding for seasonal needs.
– Bridge-to-bond or equity closings: DDTLs can bridge timing gaps until permanent financing closes.
Pricing and fees — formulas and examples
– Interest on drawn amounts: Interest = Drawn principal × (Reference rate + Spread). Example: If a borrower draws $50 million, SOFR = 1.25% and spread = 3.00%, annual interest = 50,000,000 × 0.0425 = $2,125,000.
– Commitment fee on undrawn amounts: Commitment fee = Undrawn commitment × Fee rate × (Days outstanding / Day count convention). Many facilities use 30/360 or ACT/360. Example: $100 million facility, $50 million undrawn, commitment fee = 50,000,000 × 0.50% × (180/360) = $125,000 for the half-year.
– Upfront fees and agency fees: One-time arrangement or upfront fees reduce net proceeds and should be annualized for economic comparison.
Worked numeric example (step-by-step)
Assumptions:
– Total DDTL commitment: $100 million. Availability window: 12 months.
– Borrower draws $40 million on day 60 and $30 million on day 240 (so $30 million remains undrawn at day 240).
– Reference rate = 1.50% (ACT/360). Spread = 3.00%. Commitment fee = 0.40% on undrawn amounts (ACT/360).
Step 1 — Interest on first draw (day 60 to day 240 = 180 days):
– Daily rate = (1.50% + 3.00%) / 360 = 0.0041667% per day.
– Interest = 40,000,000 × (0.045 × 180/360) = 40,000,000 × 0.0225 = $900,000.
Step 2 — Interest on second draw (day 240 to day 365 = 125 days):
– Interest = 30,000,000 × (0.045 × 125/360) = 30,000,000 × 0.015625 = $468,750.
Step 3 — Commitment fees on undrawn balances:
– From day 0 to day 60 undrawn: $100M × 0.40% × (60/360) = $66,667.
– From day 60 to 240 undrawn: $60M × 0.40% × (180/360) = $120,000.
– From day 240 to 365 undrawn: $30M × 0.40% × (125/360) = $41,667.
– Total commitment fees ≈ $228,334.
Totals for the year (excluding upfront fees and other charges):
– Interest on drawn amounts = $1,368,750.
– Commitment fees on undrawn = $228,334.
– Combined cash cost ≈ $1,597,084.
Key risks for lenders and borrowers
– For lenders: Demand risk (borrower draws at worst time), credit deterioration between signing and draw, and limited time to reassess borrower before advance. Lenders often include strict conditions precedent.
– For borrowers: Commitment fees and covenants impose costs and restrictions even before using proceeds; failure of conditions can block needed funding at the drawdown date.
– Market risk: Reference rate shifts change floating-rate interest expense; basis risk can emerge when mixed-rate liabilities are present.
– Documentation risk: Ambiguities in conditions precedent or definition of “available” can lead to disputes.
Covenant design — practical checklist
– Determine covenant type: Maintenance covenants (continuous requirement) vs. incurrence covenants (triggered by actions such as additional borrowings or distributions).
– Set measurement frequency: Monthly
Set measurement frequency: Monthly, quarterly, or annually depending on the borrower’s cash‑flow volatility and lender monitoring needs. More frequent testing increases monitoring cost but reduces information lag; less frequent testing reduces administrative burden but elevates lender risk.
Specify the measurement date and look‑back/rolling periods
– Define the measurement “test date” (e.g., last day of each fiscal quarter).
– If using trailing measures (e.g., LTM EBITDA), explicitly state the look‑back period (last twelve months) and the treatment of incomplete periods.
– Clarify whether interim financials are unaudited and whether audited statements control if there is a discrepancy.
Define exact calculation methods (be precise; ambiguity causes disputes)
– For ratios, state numerator and denominator line‑by‑line (e.g., “Total Net Debt: outstanding principal of all borrowings excluding letters of credit, minus unrestricted cash as shown on balance sheet”).
– When using EBITDA, define: “EBITDA means consolidated net income before interest, taxes, depreciation and amortization, adjusted for (a) non‑recurring items, (b) customary management earn‑outs, and (c) other agreed add‑backs.” List permitted add‑backs specifically and cap any single add‑back if needed.
– For covenant components that reference GAAP, specify the applicable accounting standard (e.g., U.S. GAAP) and treatment of accounting changes.
Worked numeric example — leverage covenant
– Covenant: Total Net Debt / LTM EBITDA ≤ 3.0x, tested quarterly.
– Suppose at quarter end: Gross Debt = $450m; Cash (unrestricted) = $30m; therefore Total Net Debt = $420m. LTM EBITDA = $150m.
– Ratio = 420 / 150 = 2.80x — covenant in compliance.
– If the borrower plans an acquisition adding $60m of debt and $10m EBITDA pro forma, lenders will insist on a pro forma test: Pro forma Net Debt = 480 − 30 = 450; Pro forma EBITDA = 160; Ratio = 450 / 160 = 2.81x. Still compliant, but much closer to the 3.0x limit.
Pro forma and carve‑out rules
– Specify permitted pro forma adjustments (e.g., acquisitions, divestitures, cost synergies) and required evidence (auditor review, certified management projections).
– Limit the look‑forward window for pro forma adjustments (commonly 12 months).
– If add‑backs are material, include caps (absolute dollar or percentage of EBITDA) and look‑back tests to prevent recurring operating items being treated as one‑time.
Baskets and springing provisions
– Baskets: pre‑agreed amounts allowing specified actions (permitted debt, restricted payments, capital expenditures) without breaching covenants. State reset timing (annually, cumulative).
– Springing covenants: a covenant that only applies if a triggering event occurs (e.g., debt > X). Use sparingly; document triggers precisely.
Grace periods, cure and waiver mechanics
– Grace periods: allow short timeframe to remediate a covenant breach (commonly 1–30 days) before default is declared. Define whether interest continues to accrue and whether fees increase.
– Cure rights: define permitted remedies (e.g., injection of equity, sale of assets) and timing. Specify whether cures require lender consent or can be automatic.
– Waiver mechanics: require majority or unanimous lender consent? State voting thresholds and fees for waivers.
Materiality and de minimis thresholds
– Include materiality thresholds for items that affect covenant calculations (e.g., exclude write‑offs below $X). This avoids constant technical breaches over trivial amounts.
Reporting, notifications and information covenants
– Require delivery schedule for financial statements, compliance certificates signed by an officer, and supporting schedules for covenant calculations.
– Define timing (e.g., within 45 days of quarter end for unaudited results). Late delivery can itself be an event of default; include a short grace period to avoid harsh outcomes from administrative delays.
Cross‑default and cross‑acceleration provisions
– Cross‑default: a default on other indebtedness triggers default under this agreement if above a threshold. Set explicit thresholds and carve‑outs for immaterial obligations.
– Cross‑acceleration: acceleration of other debt may accelerate this debt — again, define limits and notice/curing opportunities.
Negotiation priorities — lender vs borrower checklist
Lenders typically push for:
– Maintenance covenants with strict measurement and no generous add‑backs.
– Short reporting timelines and strong information rights.
– Low thresholds for cross‑defaults and wide covenant coverage.
Borrowers generally seek:
– Incurrence covenants instead of maintenance covenants (only tested when taking an action).
– Broadly defined baskets and higher caps on add‑backs.
– Longer cure periods, looser reporting timing, and clear definitions to avoid disputes.
Sample covenant language snippets (illustrative, not legal advice)
– Measurement: “Leverage Ratio” means on any Test Date, Total Net Debt divided by LTM EBITDA, each calculated on a consolidated basis in accordance with U.S. GAAP.
– Add‑backs: “EBITDA shall be adjusted for up to $15 million per annum of costs reasonably expected to result in annual run‑rate savings from cost‑savings programs implemented within 12 months following the Test Date.”
Enforcement remedies and borrowing consequences
– Clarify remedies on breach: increased interest margin, payment in cash, accelerated maturity, or enforcement of security.
– For multi‑lender facilities, describe agent powers to take action
For multi‑lender facilities, describe agent powers to take action on behalf of the syndicate (for example, to consent to waivers and amendments, declare an Event of Default, accelerate repayments, or institute enforcement actions). Specify voting thresholds for different actions (typical: majority or super‑majority of lenders for waivers/amendments; 100% for certain fundamental changes). Define “Majority Lenders” and “Required Lenders” clearly, and state whether the agent may act unilaterally in urgent situations (rare and should be narrowly drafted).
Waivers and amendments
– Waiver: a one‑off release from an obligation (e.g., temporarily excusing a covenant breach). Define scope (which covenants may be waived), duration, effective date, and whether a waiver constitutes a waiver of future defaults.
– Amendment: a change to the loan agreement text (e.g., altering a covenant formula). Require written consent, list required approvals, and specify fee/payment (consent fee).
– Drafting checklist: state required lender consent thresholds; whether non‑consenting lenders are bound; any provisos for protecting certain lenders (e.g., pro rata protections or “No‑Action” clauses).
Defaults, notice, and cure mechanics
– Event of Default: enumerate events (payment default, covenant breach, insolvency, cross‑default, false representation, material adverse change). For each, define objective triggers where possible.
– Notice: require borrower notice of events reasonably promptly; require lender notice of payment default and intention to accelerate.
– Cure period: allow specific cure periods where appropriate (e.g., 10–30 days for payment defaults, 30–90 days for covenant breaches, 60–90+ days for insolvency‑adjacent issues). State whether cure can involve lender consent and whether payment of a cure amount avoids acceleration.
– Acceleration: specify that upon an uncured Event of Default, lenders may declare the principal and accrued interest immediately due and payable. Define the consequences and any grace periods.
Cross‑default and cross‑acceleration
– Cross‑default: a default under one agreement causes a default under the loan if amount or severity crosses a threshold. Define threshold amounts (commonly $5–10 million or a percentage of assets) to avoid trivial triggers.
– Cross‑acceleration: clarify whether acceleration under one document automatically accelerates the loan, or requires lender vote.
Security, enforcement, and intercreditor issues
– Security: list collateral, priority (first lien, pari passu), perfection mechanics (filings, pledges), and duties to maintain collateral value.
– Enforcement: set out remedies (foreclosure, sale, appointment of a receiver, application of cash sweep). Specify timing and required approvals for enforcement actions.
– Intercreditor agreement: where multiple creditor classes exist (e.g., term lenders, revolver lenders, mezzanine lenders, bondholders), include an intercreditor agreement that defines standstill periods, enforcement priorities, and who controls restructurings or foreclosure.
– Practical drafting note: require the borrower to cooperate in perfection steps and to reimburse reasonable enforcement/ancillary costs.
Interest, default interest, margins, and fees — worked example
– Definitions:
– Margin: the spread over reference rate paid by borrower (e.g., LIBOR, SOFR).
– Default interest: a higher rate applied after specified defaults or missed payments, designed to compensate lenders.
Worked numeric example:
– Term loan outstanding: $150 million.
– Ordinary margin: 3.50% (350 basis points) over SOFR.
– Default margin increase on covenant breach: +2.00% (200 basis points).
– Annual cash interest before breach: $150m × 3.50% = $5.25 million.
– Annual cash interest after breach (margin = 5.50%): $150m × 5.50% = $8.25 million.
– Incremental annual cash cost due to breach: $8.25m − $5.25m = $3.00 million.
If default interest is applied only to overdue amounts, calculate on overdue principal and apply default spread as specified (e.g., overdue interest rate = ordinary rate + 2%). Always check compounding rules and whether default interest starts from the payment
date, the date of acceleration, or some other trigger defined in the loan agreement.
Default-interest mechanics — worked example (overdue amount only)
– Setup:
– Overdue principal: $1,000,000 (missed payment)
– Ordinary margin: 3.50% (350 bps) over reference rate (assume reference rate here is 0% for clarity so ordinary rate = 3.50%)
– Default spread: +2.00% (200 bps)
– Default interest rate on overdue amount = ordinary rate + default spread = 5.50%
– Accrual basis: actual/365
– Days overdue: 30
– Calculation (simple, non-compounded):
– Ordinary interest on overdue amount for 30 days = 1,000,000 × 3.50% × (30/365) = $2,876.71
– Default interest for 30 days = 1,000,000 × 5.50% × (30/365) = $4,520.55
– Incremental default interest cost = $4,520.55 − $2,876.71 = $1,643.84
If the agreement states default interest applies only to the overdue amount, you do not multiply by full outstanding principal — use just the overdue portion. If the loan says default interest applies to all outstanding principal upon an event of default or acceleration, substitute total outstanding principal into the same formula.
Compounding: effect and calculation
– Check the contract: does default interest compound? If yes, identify frequency (daily, monthly, quarterly) and whether compounding is permitted by applicable law.
– Example (monthly compounding on the $1,000,000 overdue balance at 5.50% for 30 days):
– Monthly periodic rate ≈ 5.50%/12 = 0.458333% → approximate monthly compound for 30 days ≈ 1 + 0.00458333 = 1.00458333
– Interest due ≈ 1,000,000 × (1.00458333 − 1) = $4,583.33 (slightly different because compounding and period lengths vary)
– Practical note: compounding increases the effective interest and can materially raise repayment obligations, especially on large balances or long cure periods.
Common drafting variations to watch for
– Trigger: which events cause the default spread to apply? (payment default, covenant breach, cross-default, bankruptcy)
– Scope: does default interest apply to overdue interest only, overdue principal, or all outstanding amounts after acceleration?
– Start date: does default interest accrue from the missed payment date, the date lender issues notice, or the date of acceleration?
– Composition: is there a cap on the default margin; are fees and costs included in the base for default-interest calculation?
– Compounding: allowed or prohibited; frequency; statutory limits.
– Payment application: how are payments applied (fees, interest, principal)? Order of application affects outstanding balances and future default interest.
– Waivers and cure mechanics: notice requirements, grace periods, cure rights, and automatic reinstatements.
Checklist for borrowers (practical negotiation points)
1. Limit triggers: restrict default spread to payment defaults rather than covenant technicalities.
2. Narrow scope: confine default interest to overdue amounts; avoid application to the entire outstanding balance upon a non‑monetary breach.
3. Add cure/grace periods: negotiate reasonable notice and cure periods before default interest kicks in.
4. Cap the spread: set a negotiated maximum default margin (e.g., no more than 200–300 bps).
5. Prohibit compounding or limit frequency: prevent runaway accruals.
6. Clarify payment application: ensure payments apply first to interest (ordinary and default) per agreed order or to principal as beneficial.
7. Seek waiver mechanics: explicit procedures for waivers and retroactive rescission of default interest on cured defaults.
Checklist for lenders (practical drafting points)
1. Clear triggers: draft unambiguous event-of-default definitions that activate default interest.
2. Broad scope where necessary: state whether default interest applies to all amounts upon acceleration.
3. Start date and notice: specify accrual start date and whether notice is required.
4. Compounding and enforcement: include compounding if permitted; provide rights to apply payments and accelerate.
5. Include remedies: cross-default, increased covenants, enforcement steps,
…enforcement steps, including (a) accelerated repayment, (b) set-off rights against borrower accounts, (c) judicial remedies and self-help where permitted, and (d) intercreditor enforcement coordination when multiple creditors exist. 6. Intercreditor and pari passu effects: explain how default interest interacts with senior/subordinated creditors; specify whether default interest increases constitute a change in seniority or a prohibited payment to subordinated parties. 7. Reporting and audit rights: reserve the right to audit borrower records relevant to interest and payments to verify trigger events and calculation accuracy. 8. Mitigation and cure mechanics: provide clear cure periods, information rights during cure, and whether default interest will be automatically rescinded on cure or require an express waiver.
Checklist for borrowers (practical negotiation points)
1. Narrow triggers: limit what counts as an event of default for triggering default interest (e.g., payment defaults only, not minor covenant breaches). Define materiality where appropriate.
2. Grace and cure periods: insist on reasonable grace periods (commonly 3–30 days for payment defaults) and longer cure windows for covenant defaults before default interest applies.
3. Cap the spread: negotiate a maximum premium over the ordinary rate (e.g., 150–300 basis points instead of unlimited or punitive uplifts). Basis points (bps) = 1/100th of 1%; 100 bps = 1%.
4. No automatic compounding: prohibit or limit compounding frequency (e.g., disallow compounding or limit to quarterly) to avoid exponential growth. Define compounding method explicitly if allowed.
5. Retroactive rescission: require that, if a default is cured, default interest be rescinded or refunded retroactively to the cure date, unless lender can show actual loss.
6. Payment application favorable to borrower: specify that payments apply to accrued fees and interest in a borrower-favorable order (e.g., ordinary interest before default interest; principal last), if commercially reasonable.
7. Notice and proof: require lender to give written notice with calculation detail before default interest begins; permit borrower to dispute calculations within a defined period.
8. Limit scope: confine default interest to outstanding funded amounts, not to future unfunded commitments or contingent obligations (unless lender has a clear commercial reason).
Worked numeric example — how much more can default interest cost?
Assumptions:
– Outstanding principal: $10,000,000
– Ordinary interest rate: 5.00% per annum (p.a.)
– Default interest premium: +300 bps (3.00%), so default interest = 8.00% p.a.
– Period of default: 180 days (assume 360-day year for money-market convention)
Simple interest calculation:
– Ordinary interest for 180 days = 10,000,000 × 5.00% × (180/360) = $250,000
– Default interest for 180 days = 10,000,000 × 8.00% × (180/360) = $400,000
– Extra cost = $400,000 − $250,000 = $150,000
If compounding monthly is allowed (8.00% p.a. compounded monthly):
– Monthly rate = 8.00% / 12 = 0.6666667%
– Accumulation factor over 6 months = (1 + 0.006666667)^6 ≈ 1.0408
– Effective interest = 10,000,000 × (1.0408 −