Understanding key loan terms

Term sheets in debt financing can be just as complex as in equity deals sometimes more so. It’s crucial to understand the key terms of a loan offer and to negotiate where possible to get the best (and most serviceable) debt facility for your company. 

Below are the major components you’ll encounter:

• Principal (loan amount): This is the amount you are borrowing, either as a lump sum or as a revolving facility. Make sure the principal aligns with what you need. If a lender offers more than you asked for, be cautious you don’t have to take it all (you could accept the facility but only draw what you need).
• Interest rate: The cost of borrowing, expressed as an annual percentage. Business loans often have either a fixed rate (e.g., 10% per annum) or a floating rate tied to an index like the Prime rate or SOFR plus a spread (e.g., Prime + 4%). It’s important to calculate the actual dollar cost per year based on the stated interest rate.
• Fees: Common fees include an origination fee or closing fee (1%–2% of the loan), commitment fees (for undrawn amounts on a credit line), legal fees (some lenders ask you to cover their legal costs you can negotiate this), and back-end fee, which is like an extra lump-sum fee (expressed as a percent of the loan, e.g., 3-5%).
• Repayment term and amortization: This covers how long you have until the loan must be fully repaid and on what schedule. A typical structure for growth companies is a 4-year term with interest-only for 6-12 months, then amortizing (paying principal + interest) for the remaining term or even balloon repayment (pay all principal at maturity) at the end. Understand what the monthly payments will be under each scenario.
• Collateral and security: Usually expressed as a lien on all assets or specific ones. Be aware of any personal guarantees or if they want you to maintain accounts with them (some banks require you to keep your cash deposits at the bank as part of the deal, which effectively gives them control this can be a quasi-collateral).
• Covenants: Common covenants to watch for include minimum cash (i.e., must maintain ≥ $500k in the bank), minimum revenue or ARR (i.e., must maintain at least 80% of your projected quarterly revenue – common in venture debt), EBITDA or coverage ratio requirements (more common in traditional loans), and limitations on other debt or liens. Control triggers and equity raise requirements can also appear. Due to the variety of possible covenants, you should negotiate these heavily.
• Warrants: A lender’s right to purchase some amount of your stock at a predetermined price, usually lasting 8-12 years. Pay attention to warrant coverage, typically expressed as a percentage of the loan amount. For example, 5% warrant coverage on a $4M loan means $200k. Banks tend to ask for lower warrant coverage (sometimes none or a token amount), whereas venture debt funds might ask for higher.
• Default provisions and remedies: The term sheet will outline what constitutes a default (e.g., payment default, covenant breach, bankruptcy, change of control, etc.). It will also state the lender’s rights in default which often include the right to accelerate the loan (demand full repayment), seize collateral, charge penalty interest, and so on. You generally can’t eliminate these as lenders need remedies, but ensure there are ample notice and cure periods for these unlikely events.

As you can tell, negotiating with a prospective lender involves a lot of give and take. This is where leverage matters; multiple offers let you negotiate better. If you only talk to one lender, you’ll have less power to negotiate your terms.