Use a revolving line of credit for needs that turn back into cash within the business cycle, such as receivables, inventory and seasonal swings, and a term loan for things that pay back over years, such as an acquisition, a plant expansion, a refinancing or a recapitalization. A revolver lets you draw, repay and draw again up to a limit, paying interest only on what is outstanding. A term loan is advanced once and repaid on a schedule. Lenders size a revolver against working assets and a term loan against cash flow. Most companies with $10M to $100M+ in revenue carry both.
- Revolver (line of credit)
- Revolving; draw and repay as needed, committed for a set period
- Term loan
- Advanced once; repaid on an amortization schedule or at maturity
- Revolver funds
- Receivables, inventory, seasonal and timing gaps, letters of credit
- Term loan funds
- Acquisitions, expansions, refinancings, recapitalizations
- The usual mistake
- Paying for long-lived assets out of the revolver
How each one works
A revolving line of credit (a revolver) gives the company a limit it can borrow against at any time. Money drawn to pay suppliers comes back when customers pay, and the balance goes down; the next month it goes up again. Interest accrues only on the drawn balance, though lenders commonly charge an unused-line fee for keeping the commitment open. Revolvers are committed for a set period and then renewed, re-sized or ended; some bank lines are uncommitted and can be withdrawn at any time, a difference covered in committed vs uncommitted lines.
There are two broad kinds. A cash-flow line is sized on the business's earnings and balance sheet, with covenants to protect the lender. An asset-based line has availability that moves with a borrowing base: a set share of eligible receivables and inventory. Asset-based lenders typically advance 80% to 90% of eligible receivables. See asset-based vs cash-flow lines.
A term loan is advanced in one amount, or in draws over a set period for a delayed-draw term loan, and repaid in installments of principal and interest over a set term. Bank term loans usually amortize meaningfully; unitranche and private credit term loans usually amortize lightly and leave most of the balance due at maturity. What is repaid cannot be borrowed again.
Side by side
| Revolver | Term loan | |
|---|---|---|
| Repayment | Revolves; balance rises and falls with the cycle | Fixed schedule of principal and interest |
| Re-borrowing | Yes, up to the limit or borrowing base | No; repaid principal is gone |
| Interest | On the drawn balance, plus usually an unused-line fee | On the full outstanding balance |
| Life | Committed for a set period, then renewed | Set term, often with a balance due at maturity |
| Sized on | Receivables and inventory, or the working capital cycle | Cash flow available to service debt, and the asset's life |
| Key lender tests | Borrowing base, and often a clean-up period or coverage covenant | Debt service coverage and leverage |
| Reporting | Monthly or more often: borrowing base certificate, AR and AP agings | Periodic financial statements and covenant certificates |
| Right use | Short-cycle needs that convert back to cash | Long-lived assets and one-time uses |
Match the loan to what it funds
The rule every credit officer applies is simple: the loan should repay on the same rhythm as the thing it funds. Inventory bought for the season is sold within the season, so the revolver that bought it is repaid from the sales. A production line earns its cost back over years, so the loan that bought it should run over years, and should not outlast the line.
- Receivables and inventory growth. A revolver, ideally asset-based if the company is growing fast, because availability rises with the assets.
- Seasonal build and timing gaps. A revolver. Borrowing a term loan for a seasonal need means paying interest all year on money that sits idle for part of it.
- Plant, equipment and expansion. A term loan, or a delayed-draw facility drawn as the spending happens, with a term that the assets' life and the company's cash flow support.
- Buying a business. A term loan, usually with a revolver alongside for the combined company's working capital. See using a revolver in an acquisition.
- Refinancing or recapitalizing. A term loan. Existing term debt, seller notes or a distribution to owners belong on a repayment schedule, not in the revolver.
- A permanent step up in working capital. Often a mix: part of the need is permanent and suits term debt, and the swing on top of it suits a line.
How lenders size each one
A revolver is sized to the working capital it funds. For an asset-based line, the borrowing base sets availability each day: eligible receivables at an advance rate, plus eligible inventory at a lower one. Receivables more than 90 days past invoice typically drop out, and any single customer is commonly capped at 20% to 25% of eligible receivables. For a cash-flow line, the lender looks at the company's peak need across the year, measured from the working capital cycle. A company with receivables of 600, inventory of 300 and payables of 250 at its seasonal peak has a funding gap of about 650; a revolver near that size, less whatever the company can fund from its own cash, fits the need. See how lenders size a working capital line.
A term loan is sized to cash flow. Conventional bank lenders commonly look for debt service coverage of at least 1.25x: cash flow available for debt service divided by the year's principal and interest. Senior cash-flow lenders to lower-middle-market companies also cap total debt, commonly at 2x to 3.5x EBITDA, and unitranche lenders stretch further. Most lenders count a drawn revolver in that total, so a company at its leverage limit on a term loan has less room on the revolver, and the reverse. See how much debt can my business carry.
A revolver is sized to what the company owns and is owed. A term loan is sized to what the company earns. Asking one to do the other's job is where both go wrong.
The mistakes lenders see most
Funding long-lived assets on the revolver. A company buys equipment, pays for a build-out or funds an acquisition deposit from the revolver because the money is there. The balance never comes back down. At renewal the lender sees a balance that has not moved in a year, which tells it the revolver is really term debt with no repayment schedule. Many cash-flow lines carry a clean-up requirement, a period each year when the balance must be at or near zero, precisely to catch this. The fix is to term out the stuck balance into a proper term loan, ideally before the lender asks.
Relying on a revolver that can shrink. An asset-based line's availability falls when sales fall, because receivables fall. The line is least available when a company under pressure most wants it. A cash-flow line can be reduced or not renewed if earnings slip. Neither should be the only source of liquidity for a fixed commitment.
Borrowing a term loan for a timing problem. Some companies take a lump sum to cover a seasonal gap, then carry the payments through the months when they had cash to spare. The interest is wasted, and the payments reduce the cushion for the next season.
Ignoring the covenants. Both facilities carry them. A revolver may test coverage, leverage or minimum availability; a term loan usually tests coverage and leverage. See the covenants on a line of credit and, if one has already been missed, what to do after a covenant breach.
Most companies need both
A typical company at this size carries a term loan for its long-term needs and a revolver for its working capital. They can come from one lender under one credit agreement, or from two: an asset-based lender with first claim on receivables and inventory, and a term lender with first claim on equipment, real estate and the rest, tied together by an intercreditor agreement. The second arrangement often produces more total capital, because each lender lends against what it values most. See splitting the collateral between an ABL and a term loan.
The documents differ accordingly. A revolver or ABL lender wants an AR aging by customer with days outstanding, an AP aging, a balance sheet, a P&L and year-to-date P&L, and the debt schedule with existing liens; an inventory report if inventory is in the borrowing base; and often bank statements and two to three years of business tax returns. A conventional term lender wants the P&L, year-to-date P&L, balance sheet and debt schedule, and often an AP aging.
Midas Partners's lender book holds 1,800+ lenders: 235 write asset-based loans and lines and 1,148 write term and private credit, so a company that needs both can test both sides of the market on one file. Once the documents are in, Midas Partners builds the full lender package, with the financing model, lender presentation, blind teaser and underwriting memo, in a day; by hand, the same package takes at least a week. The model sizes the revolver on the working capital cycle and the term loan on coverage and leverage, so each lender sees the split it is being asked to fund.
Common questions
- Is a line of credit cheaper than a term loan?
- Per dollar drawn, it can be, and you pay interest only on what you use. But revolvers usually carry an unused-line fee, more reporting and the risk of not being renewed. The cheaper loan is the one that matches the need: a term loan used for a seasonal gap wastes interest, and a revolver used for long-lived assets creates a renewal problem.
- Can I use the revolver to fund equipment or an expansion?
- Briefly, as a bridge until a term loan or a delayed-draw draw is in place. As a permanent arrangement, no. The balance will not come down, the lender will notice at renewal, and you will have financed a multi-year asset with a facility that can be reduced or not renewed.
- What is a clean-up period?
- A requirement, common on cash-flow lines, that the balance be at or near zero for a stretch of time each year. It proves the line is funding a cycle rather than something permanent. Asset-based lines usually do not have one, because the borrowing base already ties the balance to working assets.
- What does it mean to term out a line?
- Converting a stuck revolver balance into a term loan with a repayment schedule. It restores the revolver's availability for its real purpose and gives the lender a clear path to repayment. Lenders usually prefer the company to raise it before renewal.
- Does a drawn line count against how much term debt I can borrow?
- Usually, yes. Most lenders measure leverage on total debt, including the drawn revolver, so room on one reduces room on the other. Asset-based lenders focus more on the collateral, but a term lender alongside them will still count the revolver.