A credit facility agreement is a binding contract in which a lender commits to make a pool of capital available to a borrower, up to a set maximum, over an agreed period. Instead of handing over a single lump sum, the lender keeps capital on reserve so the borrower can draw against it as needs arise. The document itself controls everything that matters: how funds flow, what the borrower promises in return, how interest is calculated, what counts as a default, and what the lender can do when something goes wrong.
Businesses use these agreements to cover payroll gaps, finance acquisitions, buy equipment, manage seasonal inventory swings, and fund growth without having to renegotiate a new loan every time capital is needed. The flexibility is the point. So is the fine print.
How the Structure Works
Every credit facility has at least two parties: the borrower receiving capital and the lender providing it. In larger deals, a group of lenders called a syndicate splits the commitment, and one bank serves as administrative agent so the borrower deals with a single point of contact for funding requests, payments, and information flow.
Two numbers anchor the agreement. The commitment amount is the maximum principal the lender is obligated to make available. The maturity date is the deadline by which the borrower must repay or refinance the outstanding balance in full. Between those endpoints, the borrower accesses capital through drawdowns, which are formal requests for a specific portion of the committed funds. Each drawdown typically requires a minimum amount, a notice period of two or three business days, and a certification that the borrower remains in compliance with the agreement’s terms.
The lender charges a commitment fee on the portion of the facility that has not yet been drawn, compensating the bank for holding capital in reserve. On revolving facilities, commitment fees generally run from 0.25% to 1.0% of the undrawn balance per year, with stronger borrowers paying toward the lower end.
The Main Types of Credit Facilities
Most large agreements combine more than one type of facility under a single umbrella document. The structure follows the use of funds.
Revolving Credit Facility
A revolving facility works like a corporate credit line. The borrower draws, repays, and draws again, repeatedly, up to the commitment amount. Repaid principal becomes available for re-borrowing immediately. This is the right structure for short-term working capital needs: seasonal inventory, the gap between invoicing and collection, timing mismatches in payables. At maturity, the full outstanding balance comes due.
Term Loan
A term loan is the opposite of revolving credit in one critical respect: once principal is repaid, it cannot be re-borrowed. The loan is drawn at closing or during a short availability window, then paid down on a fixed amortization schedule, often with a large balloon payment at maturity. Term loans fit discrete capital investments like equipment purchases, real estate, or acquisitions, where the debt is sized to match the asset’s useful life.
Delayed Draw Term Loan
A delayed draw term loan sits between the two. It gives committed access to a term loan that can be drawn in multiple installments during a specified availability window, often three to four years, rather than requiring the full amount at closing. Once drawn, the money behaves like a standard term loan and repaid principal cannot be re-borrowed. The structure is common in private equity deals where a sponsor knows follow-on acquisitions are coming but not exactly when.
Accordion or Incremental Facility
Many agreements include an accordion feature that lets the borrower increase the total commitment, either by adding a term loan tranche or expanding the revolver, up to a pre-approved ceiling without renegotiating the entire agreement. Existing lenders have already consented to the potential increase, so the borrower avoids the time and expense of a full amendment. The borrower still has to find lenders willing to fund the increase, and the agreement caps the incremental amount, but the legal groundwork is already in place.
How Interest Is Priced
Interest on a credit facility is almost never a single fixed number. The rate is built from two components: a benchmark that floats with the broader market, and a fixed margin (also called a spread) that reflects the borrower’s credit risk.
Since the retirement of LIBOR, the standard benchmark for U.S. dollar credit facilities is the Secured Overnight Financing Rate, known as SOFR, published by the Federal Reserve Bank of New York. Most syndicated loans use Term SOFR, a forward-looking version administered by CME Group, because it lets the borrower know its interest cost at the start of each interest period rather than calculating in arrears.1CME Group. Term SOFR Some agreements use Daily Simple SOFR instead, which accrues day by day based on the overnight rate.
The margin is where the lender prices the borrower’s individual risk. A financially strong, investment-grade company might pay SOFR plus 1.25%, while a more leveraged borrower could pay SOFR plus 3.50% or more. Many agreements include a pricing grid that moves the margin up or down based on the borrower’s leverage ratio or credit rating at each measurement date, which gives the borrower a direct incentive to improve financial performance because doing so literally reduces the cost of capital.
When a facility converts from a legacy LIBOR agreement, the rate typically includes a small credit spread adjustment added to SOFR to account for the historical difference between the two benchmarks. For investment-grade facilities, this adjustment is commonly a flat 0.10%.
What the Borrower Promises
Before capital flows, the lender needs assurance that the borrower’s house is in order. The borrower provides this through representations and warranties, formal statements of fact embedded in the agreement: the company is legally organized and authorized to borrow, its financial statements are accurate, it faces no material undisclosed litigation, it is solvent, and it complies with applicable laws. Representations and warranties describe the borrower’s condition at a point in time, usually the closing date and each subsequent drawdown date.
Every drawdown request effectively re-certifies that these representations remain true. The agreement also requires that no event of default exists and that drawing the funds would not create one. These are conditions precedent, and if any one is not satisfied, the lender has the contractual right to refuse funding.
The most consequential condition precedent is often the material adverse change (MAC) clause. A MAC clause lets the lender decline a drawdown if the borrower has experienced significant deterioration in its business, financial condition, or ability to repay. Lenders rarely invoke MAC clauses because the burden falls on them to prove the adverse change is genuinely material, and litigation on this point is expensive and uncertain. The existence of the provision still gives the lender meaningful leverage in negotiations when a borrower is struggling, and a company nearing financial trouble that has not yet drawn available funds faces real risk that the lender will raise MAC concerns before funding.
Covenants: Affirmative, Negative, and Financial
Covenants are the lender’s primary tool for monitoring and controlling risk throughout the life of the facility. They come in three types, and violating any one of them, even while making every scheduled payment on time, can trigger a default.
Affirmative covenants are things the borrower must do: maintain adequate insurance, pay taxes, deliver audited annual financial statements, keep properties in good condition, comply with material laws. Most are not controversial during negotiation because they describe basic good business hygiene.
Negative covenants restrict what the borrower cannot do without the lender’s consent. Common restrictions include taking on additional debt above a set threshold, selling material assets outside the ordinary course of business, making acquisitions above a specified size, paying dividends or making distributions to equity holders, and changing the fundamental nature of the business. This is where negotiations get contentious. The borrower wants operational flexibility; the lender wants to prevent actions that increase risk.
Financial covenants are quantitative tests the borrower must pass, typically measured quarterly. The most common include a debt service coverage ratio, requiring cash flow to exceed debt payments by a specified multiple, and a leverage ratio capping total debt relative to earnings before interest, taxes, depreciation, and amortization (EBITDA). Some agreements add a minimum net worth test or a cap on capital expenditures. These covenants function as early warning systems: if financial health deteriorates, the covenant breach gives the lender a seat at the table long before the company actually misses a payment.
Collateral and Guarantees
Most credit facilities are secured, meaning the borrower pledges specific assets the lender can seize and sell if the loan goes unpaid. Common collateral includes accounts receivable, inventory, equipment, intellectual property, and real estate. The lender documents its claim through a security agreement and then perfects that claim by filing a financing statement (a UCC-1) with the appropriate state authority, usually the Secretary of State’s office. Perfection establishes the lender’s priority over other creditors who might claim rights to the same assets.
When the facility is secured by working capital assets, the lender often limits how much the borrower can draw based on a borrowing base formula. Rather than giving access to the full commitment regardless of collateral value, the lender advances only a percentage of eligible assets. A typical borrowing base might allow 80% of qualifying receivables and 50% of eligible inventory, though advance rates vary with the quality and liquidity of the collateral. The borrower submits regular borrowing base certificates, often monthly, and available credit fluctuates as the collateral pool changes.
Lenders also frequently require personal guarantees from company owners or principals, particularly for middle-market and smaller borrowers. A personal guarantee makes the individual personally liable for the company’s debt, even if the business is structured as a corporation or LLC that would otherwise shield the owner from liability.2NCUA. Personal Guarantees – Examiner’s Guide These guarantees are typically joint and several, meaning the lender can pursue any one guarantor for the full amount rather than dividing the claim proportionally. Lenders sometimes waive the personal guarantee requirement for financially strong borrowers with proven track records, low leverage, and strong collateral coverage, but for privately held companies that outcome is the exception rather than the rule.
What Happens in a Default
A breach of any covenant, a missed payment, or a failure to satisfy another obligation under the agreement constitutes an event of default. The lender’s options are far broader than simply demanding repayment.
Beyond the obvious triggers like missed payments and covenant breaches, most agreements include a cross-default provision: if the borrower defaults on any other material debt, that default also constitutes a default under the credit facility. The domino effect is intentional. Some agreements use a softer version called cross-acceleration, which only triggers a default under the facility if the other lender actually accelerates its loan, rather than triggering on the mere existence of a default elsewhere.
Not every breach brings immediate consequences. Most agreements give the borrower a cure period, typically 30 days for affirmative covenant breaches, before the breach ripens into a full event of default. Payment defaults generally have a shorter grace period or none at all.
Financial covenant breaches are trickier because you cannot retroactively change your results, which is why some agreements include an equity cure right. An equity cure allows the sponsor or owner to inject fresh equity and have that capital count toward the financial metrics as though it had been earned during the measurement period, bringing the company back into compliance on paper. Lenders accept this mechanism because new money enters the business, but they impose strict limits. A typical agreement might allow no more than two equity cures in any four consecutive quarters and three or four total over the life of the facility, with each cure capped at around 15% of EBITDA.
Once a default occurs and any cure period expires, the interest rate on outstanding borrowings typically increases by 2 percentage points above the normal contract rate. Default interest accrues automatically. More significantly, the lender gains the right to accelerate the loan, demanding immediate repayment of the entire outstanding balance. Lenders do not always exercise acceleration right away, but having the right fundamentally shifts the power dynamic.
In practice, lenders and borrowers often negotiate a forbearance agreement rather than proceeding directly to acceleration. Under forbearance, the lender agrees to temporarily refrain from exercising its default remedies while the borrower works to cure the problem, restructure the debt, or find alternative financing. Forbearance is not free. The borrower typically pays a forbearance fee, reimburses the lender’s legal and advisory costs, and accepts tighter reporting and additional restrictions during the forbearance period. It buys time at a steep price.
Getting the Deal Done and Staying Compliant
Closing a credit facility runs through a structured process, and the compliance burden continues long after funding.
The borrower assembles a due diligence package that typically includes two to three years of audited financial statements, detailed projections, a business plan explaining the use of proceeds, and organizational documents. The lender’s credit team analyzes repayment capacity, collateral quality, industry risk, and management strength.
Federal anti-money-laundering rules add another layer. Before funding, the lender must collect beneficial ownership information for anyone who controls at least 25% of the borrowing entity, including name, date of birth, address, and a government-issued identification number such as a Social Security number or passport number.3FFIEC BSA/AML InfoBase. Assessing Compliance with BSA Regulatory Requirements – Beneficial Ownership Requirements for Legal Entity Customers These requirements apply to every legal entity opening a new credit account, not just publicly traded companies. Borrowers who are not prepared for this step delay closing.
Once the lender is comfortable with the credit, it issues a term sheet, a non-binding summary of the proposed deal’s key economic terms: commitment amount, interest rate structure, maturity, fees, and headline covenants. The term sheet is the starting point for negotiation, not the finish line. The borrower and lender, with their lawyers, then negotiate the definitive credit agreement and all ancillary documents, including the security agreement, guaranty agreements, and any intercreditor arrangements if multiple lenders hold different tranches.
After closing, compliance is continuous. Drawdown requests must follow the notice procedures and satisfy all conditions precedent each time. The borrower delivers quarterly compliance certificates confirming that no default has occurred and showing, with supporting calculations, that all financial covenants have been met. These certificates come with full financial reporting packages: balance sheets, income statements, cash flow statements. Annual audited financials are required separately. Missing a reporting deadline or submitting an inaccurate compliance certificate is itself a default under the agreement, which is why experienced borrowers build compliance tracking into their accounting workflows from day one.
Tax Treatment of Interest
Interest paid on a credit facility is generally deductible as a business expense, but federal law limits how much interest a business can deduct in any given year. Under Section 163(j) of the Internal Revenue Code, a business can deduct interest expense only up to the sum of its business interest income plus 30% of its adjusted taxable income for the year.4Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Any interest exceeding the cap carries forward to future tax years, but it still creates a real cash flow cost in the year it is incurred without a deduction.
Smaller businesses get an exemption. Companies with average annual gross receipts of $25 million or less over the prior three years, adjusted annually for inflation (the 2025 threshold was $31 million), are not subject to the 163(j) limitation at all.4Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense For businesses above that line, the limitation is worth modeling before signing. A company taking on significant new debt needs to understand not just the stated interest rate but how much of that interest it can actually deduct, because the after-tax cost of borrowing may be higher than the headline rate suggests.