Term Loan
How a Term Loan Works
A lender — typically a bank or syndicate of banks — disburses the entire loan amount at closing. The borrower then repays it through scheduled payments that include both principal and interest. The interest rate can be fixed or floating (commonly SOFR + a credit spread). Maturities range from 1 year to 10+ years depending on the loan type and borrower profile.
Most term loans include covenants — financial tests the borrower must maintain, such as maximum leverage ratios or minimum interest coverage ratios. Violating a covenant can trigger default or force renegotiation.
Term Loan vs. Revolving Credit Facility
| Feature | Term Loan | Revolver |
|---|---|---|
| Disbursement | Full amount upfront | Draw as needed up to a limit |
| Repayment | Fixed amortization schedule | Flexible — repay and re-borrow |
| Interest | On the full outstanding balance | Only on drawn amounts |
| Typical Use | Acquisitions, capex, refinancing | Working capital, liquidity backstop |
| Fees | Upfront fee, no commitment fee | Commitment fee on undrawn portion |
Types of Term Loans
Term Loan A (TLA)
Amortizes evenly over the life of the loan — meaning the borrower repays principal in equal installments (e.g., quarterly). Typically held by banks and priced at a lower spread. Common in investment-grade credit facilities.
Term Loan B (TLB)
Has minimal amortization (often just 1 % per year) with a large bullet payment at maturity. Primarily sold to institutional investors like CLOs and hedge funds. Carries a higher spread than TLA because lenders take on more risk by waiting for the balloon payment.
Term Loan C / Second Lien
A subordinated layer of debt that sits behind TLA and TLB in the repayment waterfall. Higher yield for lenders, but they only get paid after senior tranches are satisfied. Common in leveraged buyout structures.
| Feature | Term Loan A | Term Loan B |
|---|---|---|
| Amortization | Even payments over the term | Minimal (1 %/year) + bullet at maturity |
| Typical Lenders | Banks | Institutional investors (CLOs, funds) |
| Spread | Lower (SOFR + 150–250 bps) | Higher (SOFR + 250–500 bps) |
| Maturity | 5–7 years | 6–8 years |
| Prepayment | Usually no penalty | Often includes soft-call protection |
Amortization Schedules
The amortization structure determines how quickly the borrower returns principal to lenders. The two main approaches:
Fully amortizing: Each payment covers both interest and a portion of principal so that the loan is fully repaid by maturity. Most Term Loan A facilities work this way.
Bullet / balloon: The borrower pays mostly interest during the term, with the vast majority of principal due as a single lump sum at maturity. Term Loan B structures follow this pattern — the minimal 1 % annual amortization means roughly 93–95 % of the principal is due at the end.
Common Uses for Term Loans
Companies use term loans to finance large, one-time needs: funding an acquisition, building a new facility, purchasing equipment, or refinancing existing debt at better terms. In LBO transactions, the term loan is often the largest component of the debt package alongside mezzanine financing and a revolver.
Term Loans on Financial Statements
The outstanding principal appears as long-term debt on the balance sheet (with the current-year portion classified as current). Interest expense flows through the income statement. Scheduled principal repayments show up in the financing section of the cash flow statement.
Example
A private equity firm acquires a mid-market company for $800 million. The debt package includes a $400 million Term Loan B at SOFR + 350 bps, a $100 million Term Loan A at SOFR + 200 bps, and a $75 million revolving credit facility. The TLA amortizes quarterly over 5 years. The TLB has 1 % annual amortization with the remaining balance due in year 7. The revolver sits undrawn as a liquidity cushion.
Key Takeaways
- A term loan provides a lump sum repaid on a fixed schedule — no re-borrowing like a revolver.
- Term Loan A amortizes evenly and is held by banks; Term Loan B has minimal amortization with a bullet payment and is held by institutional investors.
- The spread (and risk) increases as you move down the capital structure: TLA → TLB → second lien.
- Covenants protect lenders by requiring the borrower to maintain certain financial ratios.
- In LBO analysis, model the bullet maturity carefully — refinancing risk is a key concern.
Frequently Asked Questions
What is a term loan in simple terms?
A term loan is a lump-sum loan that you repay over a set period through regular payments. Think of it like a mortgage for a company — fixed amount, fixed schedule, pay it down over time.
What is the difference between a term loan A and a term loan B?
Term Loan A amortizes evenly (equal principal payments) and is typically held by banks at a lower interest rate. Term Loan B has minimal amortization with most of the principal due at maturity, is held by institutional investors, and carries a higher interest rate.
Can you prepay a term loan early?
Generally yes, but it depends on the terms. Term Loan A facilities usually allow prepayment without penalty. Term Loan B facilities often include “soft call” protection — a 1–2 % fee if you prepay within the first 6–12 months.
What is a bullet payment on a term loan?
A bullet payment is a large lump-sum principal payment due at the end of the loan term. It’s characteristic of Term Loan B structures where only about 1 % of principal is amortized annually, leaving the rest for the final payment.
How are term loans different from bonds?
Both are forms of debt financing, but term loans are privately negotiated with lenders (banks or institutions), while bonds are issued in public or private capital markets. Term loans are typically secured and senior, with tighter covenants. Bonds often have fewer restrictions but may carry higher interest rates for riskier issuers.