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Loans have evolved a great deal in the past few years. There seems to be different loan structures and finance options for most business scenarios. Among those options is the delayed draw term loan. With a delayed draw term loan, owners can access a lump sum of capital, and only draw down on what's immediately needed, almost acting like a line of credit. These loans are appealing as they allow owners to tap more capital if needed, without paying interest in the interim, but there are many considerations to account for when thinking about these loan types.
What is a Delayed Draw Term Loan (DDTL)?
A delayed draw term loan (DDTL) is a loan in which the borrower is given credit, or a loan, but allows the borrower to draw money over time, rather than immediately having the sum of the loan given to the borrower upfront.
These loans may be used for businesses who know they may have future needs for capital, but do not want to have to apply for loans or financing at these stages, but rather utilize one delayed draw term loan to pull money from the loan as needed.
These loans are popular for mature businesses which run lean, offering less time to determine financing incremental purchases and giving owners access to cash with one loan over time rather than many smaller loans.
How Does a Delayed Draw Term Loan Work?
A delayed draw term loan works in a similar fashion to a traditional loan, having a maturity date that is fixed, and interest that accrues and is paid over the life of the loan. However, different from a traditional loan, a DDTL allows borrowers to control the amount of principal which is being borrowed up to a limit.
How Does a DDTL Differ from Other Types of Loans?
There are a few key differences between DDTL and other loan types. A DDTL allows for variable timing, meaning the amount borrowed can differ over the life of the loan as borrows pull funds. Fees are also a big factor as DDTL may come with higher fees versus traditional loans.
What Are Ticketing Fees in a DDTL?
Each time a borrower draws down a DDTL, there is a ticketing fee associated with the transaction, which can typically hover around 1% of the total amount drawn, charged by the lender. So a DDTL with a $100,000.00 draw by the borrower may be accompanied by a $1,000.00 ticketing fee for the translation. This means owners should be cautious, and ready to pay, when calculating the amount they want to draw as to avoid having to make many draws in a small period of time.
Example of a Delayed Draw Term Loan
Businesses who have periodic cash needs may use these loan types, rather than financing large purchases at each increment. A business which is subject to seasonality, such as a toy manufacturer may use a DDTL to pay for holiday inventory production upfront, then later pay down the balance once cash is collected.
Delayed Draw Term Business Loan vs Short Term Business Loan
Short term loans are loans which cash is deposited in a sum to the borrower on approval of a loan. These loans typically are associated with shorter maturity dates, lower interest rates, and loan sums of money borrowed. DDTLs are nearly opposite, with longer maturity dates, higher fees, and amounts drawn by borrowers rather than given up front as lump sums.
Pros and Cons of Delayed Draw Term Loans for Business
Benefits of Delayed Draw Term Loans
There are many benefits of a DDTL with the key benefits including the flexibility of the loan, cash flow management it allows for owners, and the ability to control the amount of interest paid.
Flexibility - borrowers can draw on their loan as needed at any interval they chose, allowing the business to focus on operations without hassle of financing. While there may be a delay for the funds to release, owners can calculate for this and periodically draw amounts to strategically continue operations.
Cash flow Management - by having a line of credit available to pull on, owners may not need to spend the time and money on securing financing periodically, making this standing loan the perfect tool to manage cash flow.
Interest - owners will only be paying interest on the amounts borrowed, not the full balance of the loan unlike traditional loans. This means owners can vary the amount of interest they’re paying over time.
Drawbacks of Delayed Draw Term Loans
While these are fantastic loans for many use cases there are a few downsides with DDTLs.
Barrier to entry - these loans are difficult to secure and may require collateral to obtain, creating a high barrier to entry for many businesses. These loans are often highly complex and difficult to administer. This also makes the product limited in availability.
Fees - these loans may see higher interest rates, and fees associated with drawing money, making them expensive vehicles over time for owners.
Penalties - depending on the terms of your agreement there may be additional fees paid for any prepayments or late payments when managing your DDTL.
How to Obtain a Delayed Draw Term Loan for Business
First a business must assess and determine if this is the best type of loan for their business and financing needs, which includes understanding the terms of a loan, and forecasting how this loan could play into the business operations over a given period of time.
Next the business may want to find the DDTL product they are seeking at multiple lenders to begin understanding the requirements for the loan and comparing rates and terms.
Once a target provider or lender is determined a business would start the loan process. At this point they will be provided required documentation and information to submit to the lender for approval. At this point there may also be negotiations with the lender on any details of the term.
Once your loan is complete and approved the business will now have a DDTL that they can begin drawing on, repaying, and utilizing to maximize the businesses cash flows and operating potential.
Tips for Repaying Your Delayed Draw Term Loan on Time
A business with a delayed draw term loan will have access to capital as needed, however the balance drawn may be subject to higher interest rates, making a repayment plan necessary. Here are a few tips you can follow when considering repayment
- Create a repayment plan - assuming things go as planned and your capital is making a return, having a baseline repayment plan will hold your business accountable to an expected outcome of interest and payments.
- Automate payments - when possible can you autopay your balance down on an expected cadence, automating your plan?
- Prioritize your loan payments - be sure to not avoid repaying your loan as interest will continue to accrue over time
- Consider refinancing - if you find yourself in a position where better rates may exist, or consolidation of your loan may sense, create the scenarios where a refinance may make sense.
- Communicate with your lender - whether you’re going to be late on payment, or want to pay in full, having a lender in your corner to advise on the best course of action is an advantage to be taken.
Alternatives to Delayed Draw Term Loans
Delayed draw term loans are appealing for many, but there are other instruments which may save you money and time, have lower barriers to entry, and achieve the same financing result you’re looking for. When considering a DDTL be sure to also include research on microloans, lines of credit, and short term business loans. Be sure that the best financial outcome is achieved when you select a loan product to go with, and always talk to a lender if you’re unsure of the best course of action.