What is a credit facility?
A credit facility is a type of preapproved loan that businesses can access on an ongoing basis, rather than having to take out the whole loan at once. The size of a credit facility is like the limit on a credit card: businesses can access up to the full amount of the credit facility, but they are more likely to access a portion of the credit facility and pay back their loans on an ongoing basis.
Let's say you operate a business that needs working capital. Whether you're funding operational purchases or issuing loans to customers, a credit facility is a line of credit that can offer flexible financing, enabling you to take advantage of debt capital without having to use your company's equity.
When are credit facilities the right option for businesses?
Companies should consider credit facilities when their businesses require them to finance ongoing activities with a mix of equity and debt. For companies that have just raised equity financing, credit facilities may offer a way to incorporate debt into the capital stack in a way that minimizes the long-term cost of capital.
Credit facilities are not a good option for large one-off purchases that need to be paid back over a long-time, especially if those purchases cannot be paid down in the short-term. If financing the construction of a factory, for example, it would make more sense for a business to take out a long-term loan with a low interest rate.
The reason for this is that credit facilities are in some ways more expensive than long-term loans. A credit facility provides consistent access to funding, but that availability comes with an access fee (and often a higher interest rate), so credit facilities are better suited for purchases that can be paid off more quickly and for companies that require flexibility in addition to capital.
What can credit facilities be used for?
In general cases, credit facilities can be used for whatever a business needs to spend money on, whether it's bills, special projects, extra inventory, or unforeseen expenses. The loan amount of a credit facility has no practical limit. That said, there are certain categories of credit facilities that can only be used for specific purposes.
Asset-backed credit facilities (also referred to as ABL credit facilities), for example, can only be used for consumer or business lending. These are the types of credit facilities that a fintech might access when they want to ramp up their lending operations quickly, using their receivables as collateral. This is in contrast to cash-flow credit facilities, which are sized and priced based on a business' past revenue.
Want to learn more?
Whether to raise a credit facility is just one of the many capital markets-related questions that companies have to get right as they plan their debt and equity raises. In the future, we'll focus on revolving credit facilities and asset-backed credit facilities (two options that startups often consider) in more detail.
In the meantime, if you're interested in learning more about technology that can streamline your credit agreement and facility management, just schedule a demo of Finley here. We'd love to chat!
