What Is a Delayed Draw Term Loan and How Does It Work?

A delayed draw term loan (DDTL) provides businesses with committed capital that can be accessed in installments over time, rather than as a single lump sum. This financing structure supports ventures requiring staggered capital injections, aligning funding with specific project milestones or evolving expenditure schedules. It offers a structured approach to capital access, allowing borrowers to manage their funding needs as they arise.

Defining Delayed Draw Term Loans

A delayed draw term loan is a business loan where a borrower accesses predefined portions of a total approved amount over a specified period. Unlike traditional term loans, which disburse the entire amount upfront, a DDTL releases funds at predetermined intervals or upon achieving certain milestones. This structure allows a business to draw funds incrementally to meet evolving funding needs, providing flexibility in capital deployment.

A DDTL commits the lender to provide a certain amount of capital, which the borrower can draw down over a defined “draw period” or “availability period.” Interest accrues only on amounts actually drawn, potentially reducing overall interest costs. Once a portion is repaid, those funds cannot be redrawn, similar to a standard term loan. This distinguishes it from a revolving line of credit, where repaid funds can usually be re-borrowed. DDTLs are generally long-term financing for specific projects, while revolving lines are often for short-term working capital needs.

Key Structural Components

The structure of a delayed draw term loan involves several specific elements that define its operation and cost. The “commitment amount” refers to the total principal sum the lender agrees to make available over the loan’s term. This represents the maximum capital that can be drawn.

The “draw period,” also known as the availability period, is the timeframe during which the borrower is permitted to request disbursements from the committed amount. This period can vary, allowing for multiple tranches or installments of funds to be drawn as needed. Lenders may impose conditions, requiring the borrower to meet specific financial ratios or project milestones before authorizing a draw.

Interest rates on delayed draw term loans apply only to amounts that have been drawn, not the entire committed facility. These rates are often floating, tied to a benchmark such as the Secured Overnight Financing Rate (SOFR), and adjust periodically based on market conditions. This helps manage interest expenses, as the borrower avoids paying interest on capital not yet utilized.

Lenders charge “commitment fees” on the undrawn portion of the committed capital during the draw period. These fees compensate the lender for reserving the funds and range around 0.25% to 1.00% per annum of the undrawn amount. Some loans may also include “ticking fees,” which can accumulate on the undrawn balance if the commitment remains outstanding.

“Upfront fees,” also known as arrangement fees, are initial charges paid by the borrower for arranging the loan. These fees are usually a percentage of the total loan amount. The “repayment schedule” for drawn amounts dictates how principal and interest will be repaid, typically through consecutive quarterly installments or sometimes with a bullet payment of the full principal at maturity. Loan agreements also include “covenants,” which are specific financial or operational conditions the borrower must maintain throughout the loan’s life.

Common Applications and Borrower Considerations

Delayed draw term loans are used when businesses require capital over an extended period with uncertain or staggered needs. Project financing is a common application for large-scale endeavors like construction, infrastructure development, or real estate projects, where funds are needed at different stages. This structure allows funding to align with project timelines and expenditure requirements.

Mergers and acquisitions (M&A) represent another use case, especially for financing acquisitions where portions of the purchase price or integration costs are spread out. DDTLs provide committed financing for anticipated acquisitions without requiring immediate full payment of interest on the entire sum.

Businesses seeking growth capital for expansion initiatives, such as investing in new equipment, facilities, or market penetration, also utilize DDTLs. In the technology sector, venture debt often incorporates delayed draw features, allowing startups to access capital as they achieve specific milestones or secure subsequent equity rounds.

Borrowers considering a delayed draw term loan should evaluate several factors. Flexibility in funding is a primary consideration, as it allows businesses to access capital only when necessary, aligning cash inflows with actual project or operational needs. This structured access to funds can lead to better cost management, since interest is only charged on drawn amounts, and commitment fees apply to the undrawn portion, potentially reducing overall financing expenses compared to a lump-sum disbursement.

A DDTL helps businesses avoid holding excess cash from an immediate lump-sum disbursement. Lenders conduct thorough due diligence, assessing the borrower’s financial health and the viability of the projects or acquisitions being financed. Borrowers must carefully project their future capital needs and define a realistic draw schedule to optimize the loan’s structure and ensure the committed amount is appropriate.