Revolver vs Term Loan
Definition
Revolving credit facilities ('revolvers') provide borrowing capacity that can be drawn, repaid, and redrawn repeatedly within commitment period—functioning like corporate credit cards with large limits. Term loans provide lump-sum financing at closing with required amortization over fixed maturity—functioning like mortgages. Key differences: Revolvers charge commitment fees on undrawn amounts (typically 35-50 bps), have no scheduled amortization, and are secured super-senior. Term loans provide immediate funding, charge interest only on drawn amounts, and amortize principal over 5-7 years. Companies typically use revolvers for working capital fluctuations (inventory builds, seasonal needs) and term loans for acquisitions, capex, or refinancing.
Why it matters
Revolver vs term loan structure determines liquidity availability and cost during stress. Companies with large revolver capacity can draw cash pre-emptively when credit markets seize (March 2020: $200B+ drawn in 2 weeks), preserving operations through crisis. However, revolvers include Material Adverse Change (MAC) clauses allowing lenders to refuse draws during stress—creating false sense of liquidity. Term loans provide certainty (funded at closing) but require principal payments during stress when cash flows weakest. Understanding mechanics explains why companies with $100M revolvers can still face liquidity crises (MAC clause invoked, revolver unavailable) while term loan borrowers survive (cash already drawn, no MAC exposure).
Common misconceptions
- •Revolver capacity isn't guaranteed liquidity—MAC clauses allow lenders to refuse draws during stress. Many borrowers discovered 2020 that $50M undrawn revolvers became $0 available when MAC clauses invoked.
- •Commitment fees aren't optional—borrowers pay 35-50 bps annually on undrawn revolver capacity regardless of usage. $100M revolver drawn at 50% still incurs $175K annual fees on undrawn $50M.
- •Term loans aren't always fully amortizing—many institutional term loans have bullet maturities (no required amortization). Middle-market term loans typically amortize 5-10% annually with balloon payment at maturity.
Technical details
Revolver mechanics and commitment structures
Draw and repayment flexibility: Borrowers can draw revolvers via borrowing notice (3-5 business days advance notice), repay at any time without penalty, and redraw repeatedly. Example: Company draws $30M Monday for acquisition, repays $10M Friday from asset sale, redraws $15M next month for inventory build. No limit on draw/repay cycles provided within commitment.
Commitment fees and economics: Borrowers pay commitment fees on unused portion (average daily unused balance × commitment fee rate). Example: $100M revolver, 0.40% commitment fee, average 60% drawn ($40M unused). Annual commitment fee = $40M × 0.40% = $160K. Combined with interest on drawn amounts, effective cost depends on utilization pattern.
Borrowing base calculations: Asset-based revolvers limit draws to percentage of eligible collateral. Formula: Borrowing Base = (Eligible A/R × 85%) + (Eligible Inventory × 50%) - Reserves. Example: $50M A/R, $40M inventory → Borrowing Base = ($50M × 85%) + ($40M × 50%) = $62.5M maximum draw. Daily calculation required; borrowings must stay within base.
Super-senior revolver priority: Revolvers typically pari passu with term loans in first lien position, but cash flow priority for revolver (paid before term loan despite equal liens). Creates effective super-seniority. Rationale: Revolvers fund operations; must be repaid to maintain working capital cycle. Term loans can defer.
Term loan mechanics and amortization
Funding at closing: Term loans fund in single draw at closing. Borrower receives full commitment ($100M term loan = $100M cash at close). No future borrowing capacity—if company needs additional capital later, must arrange new financing or issue bonds. Certainty of funding vs revolver flexibility.
Amortization schedules: Middle-market term loans typically require 5-10% annual principal amortization (1.25-2.5% quarterly). Example: $100M term loan, 5% annual amortization = $5M/year or $1.25M quarterly. Remaining 95% due at maturity (balloon payment). Institutional term loans often 1% annual amortization or bullet maturity (0% amortization).
Mandatory prepayments: Excess cash flow sweeps (typically 50-75% of ECF must prepay term loan), asset sale proceeds (75-100% of net proceeds), debt issuance proceeds (100% of net proceeds used to prepay). Prepayments reduce term loan balance permanently—cannot reborrow. Revolvers don't have mandatory prepayments (except if borrowing base declines).
OID and upfront fees: Term loans typically include 1-3% OID (original issue discount) providing lenders upfront yield. Revolvers generally have no OID but may include upfront fees (0.25-1.00%). Cost structures reflect different risk profiles—term loans higher default risk over 7-year life, revolvers shorter-duration exposure.
Material Adverse Change (MAC) clauses
Standard MAC language: 'Lenders may refuse funding if material adverse change has occurred in borrower's business, operations, or financial condition.' Intentionally vague—allows lender discretion. Borrowers negotiate MAC definitions but rarely achieve bright-line tests (MAC clauses function as general outs).
MAC invocation scenarios: Lenders invoke MACs during systemic stress (2008, 2020) when multiple borrowers stressed simultaneously. Individual company defaults rarely trigger MAC (lender relationship considerations). But during panics, lenders refuse all draws to preserve capital and reduce exposure. Creates pro-cyclical dynamic—liquidity disappears when most needed.
Legal enforceability: MAC clauses challenged in courts with mixed results. Borrowers argue MAC inappropriate given normal business volatility. Lenders argue material deterioration occurred. Litigation expensive and slow—by the time resolved, borrower often bankrupt. MAC utility is deterrent, not legal certainty.
Post-2020 MAC amendments: Many borrowers negotiated MAC elimination or tightening during 2020-2021 refinancings. Language like 'MAC does not include pandemics, economic downturns, or industry-wide events' excludes systemic risks. Preserves revolver availability during crises—exactly when needed. Lenders accepted amendments during strong markets but will resist next cycle.
Strategic capital structure considerations
Optimal revolver sizing: CFOs balance commitment fees (cost of unused capacity) vs liquidity insurance (capacity to draw during stress). Rule of thumb: Revolver = 2-3 months operating expenses + seasonal working capital needs. Over-sized revolvers waste fees; under-sized create liquidity risk. Most companies maintain 50-70% average utilization.
Revolver vs term loan pricing: Revolvers typically price 25-50 bps tighter than term loans (L+375 revolver vs L+425 term loan) despite equal liens. Reflects lower risk—shorter duration, working capital uses vs acquisition/dividend uses, and super-senior priority. However, commitment fees add cost—all-in revolver cost depends on utilization.
Asset-based lending (ABL) structures: Alternative to cash flow revolvers, ABL revolvers secured by specific collateral (A/R, inventory) with borrowing base mechanics. ABL revolvers size up to 85% of eligible A/R + 50% of inventory (vs cash flow revolvers at 1.5-2.5× EBITDA limit). ABL better for asset-heavy businesses; cash flow revolvers better for service businesses.
Term loan add-ons: Borrowers with existing term loans can arrange 'incremental facilities' adding new term loan tranches (if credit agreement allows). Incremental term loans function like delayed draws but require lender consent and often tighter pricing. Used for acquisitions, capex, or refinancing. Less flexible than revolvers but provides term debt at need.