Key Takeaways
- A credit facility is a preapproved type of financing that can function as a revolving line of credit or conventional term loan.
- Credit facilities offer flexible financing that business owners can use to finance various expenses, including working capital, new facility costs, general business costs, and refinancing existing debts.
- A credit facility is typically not suitable for purchases that require long-term borrowing arrangements, such as financing real estate property.
Definition and Examples of a Credit Facility
A credit facility is a funding solution that businesses can use to finance various expenses during a predetermined term. Credit facilities can be revolving, which means the borrower can withdraw some or all of a predetermined amount until the end of the term. Credit facilities can function as conventional term loans as well.
Note
Credit facilities are generally available through brick-and-mortar banks. Credit facilities in high amounts are sometimes syndicated, where multiple financial institutions extend a portion of the borrower’s total available credit.
A credit facility can be useful for addressing cyclical demands that seasonal businesses face. A tour guide company in Hawaii, for example, has its peak season during the summer. A revolving credit facility can help the company navigate cash flow crunches, such as meeting payroll, during slower months in the winter.
How Does a Credit Facility Work?
Credit facilities can operate as a revolving line of credit—the business that gets the line of credit withdraws up to a certain limit when the situation demands it—but this is not always the case. A credit facility can also function as a term loan, where the funds are disbursed in a single advance, and amounts repaid can’t be reborrowed.
Credit facilities are often characterized by their versatility. Gaurav Sharma, a former banker and founder of BankersByDay, told The Balance in an email, “Most types of loans are approved for a specific purpose, but credit facilities can be used for a wide variety of business needs, which is the main differentiating factor and the reason why most businesses prefer to have at least one such credit facility.”
Eligible expenses under a credit facility can include:
- Repayment or refinancing of existing debt agreements
- Acquisitions of other businesses
- Share repurchases
- Expenses related to new facilities
- Working capital
- Covering influx of orders
- General corporate expenses
The flexibility of a revolving credit facility makes it ideal for navigating cash-flow crunches. “The advantage of credit facilities is that they can be used for miscellaneous business expenses,” Sharma said. “So if there is an unforeseen expense or a minor shortfall somewhere, they can come in handy.”
Let’s say, for example, that a retailer is experiencing an unexpected revenue shortfall due to declining sales. However, the retailer has cash flow tied into opening a second location. A credit facility can give the retailer the financing it needs to navigate this cash-flow crunch.
As with many other financial products, credit facility interest rates are typically set at a base rate plus a spread. For revolving credit facilities, interest applies only to the amount drawn and can be repaid as cash becomes available—as long as the full amount borrowed is repaid by the end of the term.
Alternatives to a Credit Facility
“While credit facilities are great for meeting small generic expenses, other specialized lending products offer better terms for specific-use cases,” Sharma said. “For example, banks offer specialized project financing, trade financing, channel financing, working capital and term lending products for specific-use cases. These products may only be used for the specific purpose they are approved for, but they offer better terms than credit facilities.”
Note
For single large-ticket purchases, a business may want to look into long-term financing solutions. Equipment loans, for example, are ideal for spreading the cost of an expensive piece of equipment over several years.
Is a Credit Facility Worth It?
Since a credit facility can be used for various expenses, it can be useful for general-purpose business financing. This, however, can lead to higher costs and requirements.
“[A credit facility’s] general nature increases the risk of such facilities from the perspective of the lender,” Sharma said. “Hence, such facilities have higher rates and collateral requirements compared to other specialized products.”
Depending on your needs, it may be worth looking into the alternative financing solutions mentioned.
Business owners should be aware of credit facility terms. Some credit facilities have terms of less than one year, and are typically unsuitable for long-term business needs. Specifically, swingline loans offered under credit facilities are sometimes repaid within weeks.
Requirements for a Credit Facility
Requirements can vary by the lender and the business owner’s background and qualifications. A lender may take note of the quality of a business’s accounts receivable. A personal guarantee or collateral may also apply to secure the amount being requested.
Some lenders may have industry-specific requirements. A lender extending credit to a retail company, for example, may want to assess the company’s inventory management system and appraise its inventory.
