When it comes to financing a project or business venture, there are a variety of options available. One such option is a delayed draw facility, which allows borrowers to access funds in stages rather than receiving a lump sum upfront. Delayed draw facilities are often used for large-scale projects, such as real estate development or infrastructure projects, where financing needs may fluctuate over time.
This guide will provide a comprehensive overview of delayed draw facilities, including what they are, how they are structured, and the advantages they offer for borrowers.
What Are Delayed Draw Facilities?
Delayed draw facilities (DDFs), also known as drawdown facilities or revolving credit facilities, are a type of financing that provides borrowers with the flexibility to access funds over an extended period of time. Unlike traditional loans, where the borrower receives the entire loan amount upfront, delayed draw facilities allow borrowers to draw down funds as needed up to a predetermined maximum amount.
The borrower only incurs interest on the amount drawn rather than the full loan amount, which makes them an ideal financing option for large-scale, ongoing projects. They are often used in project finance, real estate development, and corporate financing where the borrower requires flexibility in funding and where financing needs may fluctuate over time. For example, a real estate developer may need to finance construction costs over several years as the project progresses and milestones are met. A delayed draw facility allows the developer to manage their cash flow more effectively and only draw funds when needed, preventing them from taking on more debt than necessary and helping them avoid unnecessary interest payments on unused funds. The unused portion of the loan remains available for future draws, subject to the terms of the agreement.
How Delayed Draw Facilities Are Structured
Because delayed draw facilities are typically secured loans, they may offer lower interest rates than unsecured loans. The structure of delayed draw facilities can vary, but they typically require collateral to secure the loan, such as real estate or equipment. The lender may also require the borrower to make regular interest payments on the outstanding loan balance.
Delayed draw facilities are structured in a way that allows borrowers to access funds in stages. Typically, the borrower will negotiate a maximum loan amount with the lender and then draw down funds as needed up to that maximum amount. In some cases, delayed draw facilities may include a “bullet repayment” provision, which requires the borrower to repay the entire loan amount at the end of the loan term. This can be a risky proposition for borrowers, as they may not have the funds available to make the repayment when it is due.
Here are some of the DDF terms that can be negotiated between the borrower and lender:
- Commitment Period: The commitment period is the time during which the lender is obligated to provide financing. This period may be several years, depending on the borrower’s needs and the type of project being financed.
- Drawdown Period: The drawdown period is the time during which the borrower can draw funds from the facility. This period may be shorter than the commitment period and may be divided into multiple stages or tranches.
- Drawdown Limits: The drawdown limits specify the maximum amount that can be drawn at any given time. These limits may be structured as a percentage of the total facility or may be based on specific milestones or financial ratios.
- Fees: Lenders may charge fees for setting up and maintaining a delayed draw facility, including commitment fees, unused line fees, and extension fees. These fees can vary depending on the lender and the terms of the agreement.
- Interest Rates: The interest rate on a DDF is typically variable and may be based on a benchmark rate, such as LIBOR or the prime rate. The interest rate may also be structured as a margin above the benchmark rate, which can vary depending on the borrower’s creditworthiness and the level of risk associated with the project.
- Conditions Precedent: The lender may require certain conditions to be met before the borrower can draw funds, such as achieving specific project milestones or meeting financial ratios. These conditions help to manage the risk of the lender and ensure that the borrower is on track to meet their objectives.
- Repayment Schedule: The repayment schedule specifies how and when the borrower will repay the funds drawn from the delayed draw facility. This may be structured as a balloon payment at the end of the commitment period or as a series of amortizing payments over time.
Borrower Advantages of Delayed Draw Facilities
We briefly discussed some of the advantages that borrowers can enjoy with DDFs, but let’s dive deeper into some of the top benefits that would be the most appealing for borrowers.
Flexibility
With a traditional loan, the borrower receives the full loan amount upfront and begins paying interest immediately, even if they don’t need all the funds right away. This can be costly, as the borrower is paying interest on funds that they are not yet using. This isn’t the case with delayed draw facilities, where borrowers pay interest only on the amount drawn. DDF terms can be negotiated between the borrower and lender, which allows the borrower to tailor the financing to their specific needs, which isn’t possible with more traditional loans.
Control
DDFs give borrowers greater control over their financing needs because they can draw funds whenever they need them, rather than having to commit to the full loan amount upfront. This means that the borrower can adjust their funding requirements based on the progress of the project or changes in market conditions, often leading to more successful outcomes.
Cost Savings
Because the borrower only pays interest on the amount drawn, rather than the full loan amount, they can save money on interest payments over the life of the loan. This can be especially beneficial for projects that have long gestation periods or uncertain funding needs.
Mitigates Interest Rate Risk
Since borrowers only draw funds as needed, they can avoid committing to a fixed interest rate for the full loan amount upfront. This means that the borrower can take advantage of changes in interest rates over time, rather than being locked into a fixed rate that may not be optimal for their needs.
Avoid Prepayment Penalties
With a traditional loan, the borrower may face penalties for paying off the loan early. With a delayed draw facility, the borrower can draw funds as needed and pay them back without penalty. This can be especially beneficial for borrowers who may need to pay off the loan before the end of the commitment period.
Better Risk Management
Borrowers can manage the risk associated with the project more effectively with DDFs. For example, if the project encounters unexpected delays or cost overruns, the borrower can adjust their funding requirements accordingly, rather than committing to the full loan amount upfront.
Conclusion
Overall, delayed draw facilities can be a useful financing tool for borrowers looking to finance long-term projects with flexible access to funds. It’s important for borrowers to carefully consider the structure and terms of a delayed draw facility before agreeing to it, to ensure that it meets their financing needs and aligns with their long-term goals.
Want to learn more about delayed draw facilities and how they can benefit you? Consult Saratoga Investment Corp.’s in-depth investment profile to determine if we are a good fit for your needs.