Delayed-draw term loan vs revolver: which should fund your next acquisitions?

The short version

A buyer building a company through add-ons needs two kinds of money: capital to pay for the next company, and working capital to run the combined business once it is bought. A delayed-draw term loan is built for the first. A revolver is built for the second. Both are committed by the lender at closing, both sit in the same credit agreement with the same collateral, and both cost a fee on the unused amount. That is where the similarity ends.

The detail of how a DDTL is documented, and how it differs from an accordion, is on the delayed draw term loan page. This page is about the choice a buyer actually faces at the term sheet: whether to ask for acquisition capacity as a DDTL, or rely on a larger revolver and use it for deals.

How each one works for an add-on

Why lenders limit the revolver for acquisitions

A revolver's job is to cover the gap between paying suppliers and staff and collecting from customers. A lender sizes it to that gap, and it wants the gap funded all year. A revolver drawn for a purchase price is money that is no longer there for payroll in a slow month, and a revolver fully drawn with no working capital left is one of the clearest signs of trouble a lender watches for. So credit agreements usually restrict acquisition use in one or more ways:

• A cap on the amount of revolver that can fund acquisitions, in total or per deal.
• A minimum availability test after the acquisition: the revolver must still have a stated amount undrawn, or a stated amount of excess availability, once the purchase is paid.
• A borrowing base that excludes the target. On an asset-based revolver, the acquired company's receivables and inventory usually count only after the lender has run a field exam on them. On the day of the deal, the revolver is sized to the old company.
• A clean-up requirement on some bank lines, which expects the balance to fall to zero or near it for a period each year. An acquisition draw that cannot be repaid from cash flow breaks it. See clean-up periods.

There is also a mismatch in how the money is repaid. A purchase price is repaid from the acquired company's earnings over years. A revolver has no schedule, so an acquisition draw tends to sit on the line indefinitely, and a line that never comes down is one a lender may decline to renew. The line of credit vs term loan comparison sets out the matching rule, and using a revolver in an acquisition covers the cases where it does work.

The revolver is the business's cushion. Spend it on a purchase price and the cushion is gone when the combined business needs it most, during integration.

What a DDTL does differently

A DDTL commits acquisition capital without making the business carry it. The money is not borrowed until a deal closes, so there is no interest on idle cash and no balance on the books between deals. The ticking fee is the cost of holding the commitment, and it is well below the interest the business would pay if it borrowed the money at closing and held it as cash. Once drawn, the DDTL repays on a schedule, which is what a purchase price should do.

The commitment is only as good as its conditions. Each draw is usually tested on a pro forma basis, meaning the platform's and the target's earnings combined, against a leverage or coverage limit set at closing. If the platform's earnings slip or the next target earns less than planned, the commitment is there and cannot be drawn. The page on lending on run-rate EBITDA explains how the target's earnings and add-backs are counted in that test.

A worked example in plain numbers. A platform earns EBITDA of 4,000,000 and borrows a term loan of 10,000,000 at closing, with a DDTL commitment of 4,000,000 and a draw condition of pro forma total leverage no higher than 3.5x. A year later it agrees to buy a company earning 1,000,000. Drawing the full 4,000,000 takes debt to 14,000,000 against combined earnings of 5,000,000, which is 2.8 times, and the draw is allowed. Had the platform's own earnings fallen to 3,000,000 in the meantime, the same draw would put leverage at 14,000,000 against 4,000,000, which is 3.5 times: exactly at the limit, with no room for any shortfall in the target's figures.

The cost of carrying each one

Before either facility is used, the borrower pays a fee on the undrawn amount: a ticking fee on the DDTL, an unused line fee on the revolver. Neither is large next to interest. The real cost comparison is what happens after the money is drawn.

• DDTL drawn for a deal. Interest on the drawn amount plus scheduled principal, which enters debt service coverage from the draw date. Coverage is tested on the combined company, so the target's earnings help pay for it.
• Revolver drawn for a deal. Interest only, with no scheduled principal, so coverage looks better in the short run. But availability falls by the full draw, and if the agreement requires minimum availability, the business may have less usable working capital than before the deal while carrying a larger company.
• Revolver upsized to leave room for deals. An unused line fee on capacity the business does not need for working capital, and a larger facility the lender must be comfortable renewing each time it comes up.

Over-committing is the DDTL's version of the same problem. A commitment sized for an optimistic pipeline costs ticking fees on capacity that is never drawn and expires unused. Size it to the add-ons you can name and expect to close within the availability period.

Which to use, and how they fit together

In practice, a buy-and-build credit facility usually has both, each doing its own job:

• Named add-ons of meaningful size go on the DDTL. Its commitment is what lets the buyer tell a seller the money is there.
• Small tuck-ins, where the price can be repaid from the combined company's cash flow within a year or so, can go on the revolver if the agreement permits it and availability stays comfortably above any minimum.
• Deals no one can name yet rely on an accordion, which pre-agrees the documents for more debt but commits no one to lend it.
• The revolver stays for working capital, sized to the combined business after each deal, which usually means asking the lender to add the acquired company's receivables to the borrowing base once it has examined them.

Lenders offering DDTLs are mainly private credit funds and some banks lending to acquisition platforms; of the 1,800+ lenders in Transparent's book, 1,148 write term and private credit. There is no SBA equivalent: each 7(a) loan is approved on its own, within the program's $5 million limit, which is covered in financing acquisitions above the SBA limit. Transparent's financing model runs the platform with each planned add-on, drawn on the DDTL or the revolver, so the commitment and the draw tests are set against figures a lender can check. See add-on acquisition financing and the lender package.