A delayed-draw term loan is a committed term loan you can pull after closing for specific purposes on set terms. It is not a revolver and not an uncommitted incremental or accordion. In sponsor deals, the delayed-draw term loan sits pari passu, meaning equal in right of payment and collateral, with the funded term loan and shares the same guarantees and liens.
Sponsors use delayed-draw term loans to lock capacity for add-on acquisitions, capital expenditures, or staged projects without paying full carry from day one. The lender prices both the option to draw later and the cost of keeping undrawn capital available. That trade only works if the documentation tracks the real plan. Loose terms let acquisition money drift into general liquidity. Terms that are too narrow strand capital and trigger renegotiation. The goal is to balance optionality, cost, and control.
What delayed-draw term loans are and are not
- Typical forms: One delayed-draw tranche inside a first-lien or unitranche facility. Some deals use a separate Acquisition Facility with bespoke conditions precedent or multiple delayed-draw pockets tied to named targets.
- Not a revolver: No borrowing base and no cash dominion. Not an accordion incremental either, because those are uncommitted and require new consents or ratio tests at the time of increase. A delayed-draw term loan is committed at signing and part of the original facilities.
- Use-of-proceeds: Acquisitions, capex, and defined permitted investments. Working capital and dividends are usually excluded, so use a revolver for that.
Stakeholder incentives and outcomes
- Sponsor: Committed dry powder for add-ons, locked pricing, one diligence cycle, less retiming risk, and less syndication or ratings uncertainty. Impact: faster close certainty.
- Lenders: Paid to keep capacity available, with tight draw conditions and time limits to manage event risk. Impact: better downside control.
- Management: Clear path to fund acquisitions without re-underwriting the core facility. Impact: lower execution friction.
Key mechanics to negotiate
Commitment and availability window
The delayed-draw amount is committed at close. Availability typically runs 12 to 18 months in private credit, with 24 months at the long end. The delayed-draw auto-terminates at expiry to avoid open tails. Shorter windows suit front-loaded pipelines; longer windows increase option cost and control tension.
Conditions to each draw
- Reps and warranties: Bringdown of representations. Use limited conditionality acquisition constructs, or LCAs, for specified acquisitions.
- No default: No event of default should be continuing. A narrow cure basket can address technical breaches tied to the draw.
- Pro forma tests: Leverage or coverage test on a pro forma basis. Use a cap equal to or tighter than closing leverage, or a fixed ceiling tied to the plan.
- Use certification: Use-of-proceeds certification, with target diligence above size thresholds.
- KYC and sanctions: Know-your-customer and sanctions checks for the target and beneficial owners, including coverage aligning with beneficial ownership reporting timelines.
Draw process and funding logistics
The borrower sends a draw notice, with minimum size and multiple rules. Lenders fund within three to five business days. Funds flow to a controlled account and then to sellers and vendors per a sources-and-uses schedule.
Payments, waterfall, and prepayments
Payments follow the same waterfall and amortization as the funded term loan, unless the tranche is a bullet. Mandatory prepayments apply pro rata to funded and delayed-draw balances to prevent gaming.
Cancellations, step-downs, and transfers
Quarterly step-downs can right-size capacity if M and A risk is high. Unused commitments cancel at expiry, and the borrower may cancel early without premium. Undrawn commitments usually transfer only to approved lenders with borrower consent to avoid last-minute syndication risk.
Sizing that matches the pipeline
- Anchor to facts: Request a pipeline with targets, EBITDA, purchase price, and timing. Include downside timing and valuation cases to reflect slippage.
- Apply haircuts: Size to 50 to 75 percent of the credible pipeline plus a modest buffer. Anything above that belongs in incremental capacity, not the delayed-draw term loan.
- Add sunset discipline: Use shorter windows and step-downs to curb option cost and strategy drift.
- Hardwire leverage: Tie draws to a pro forma leverage cap. If the sponsor wants headroom for a large add-on, push that into incremental baskets, not the delayed-draw tranche.
Pricing, fees, and option value
Delayed-draw economics compensate lenders for committed, undrawn capital and for event risk during the window. Structure them to match the plan, not to maximize notional capacity.
- Margin: Usually equal to the funded term loan if drawn early, with a 25 to 50 bps step-up after 6 to 12 months for longer availability.
- Base rate and floor: SOFR in the US and SONIA in the UK are common. Align floors across tranches so draws do not distort all-in rate. For mechanics around floors, see this primer on SOFR floors.
- Upfront economics: Original issue discount, or OID, and upfront fees can be paid on the funded piece at close and on each delayed-draw when funded. Paying OID only when drawn raises option value for the sponsor; lenders often pair it with draw OID to balance returns.
- Ticking fee: A commitment fee accrues on the undrawn balance from closing until draw or cancellation. Step-ups over time are common. The fee, paid monthly or quarterly, compensates lenders for committed capital and concentration limits.
- Call protection: If drawn, the delayed-draw typically shares the soft call with the term loan. Cancelling unused commitments usually has no premium. A minimum interest provision for near-term draws can deter quick draw-and-refi churn. For deeper mechanics, see call protection and OID.
Quick math: Assume a 500 million dollar funded term loan at SOFR plus 550 bps with a 50 bps floor and a 200 million dollar delayed-draw. The ticking fee is 50 bps for months 1 to 6 and 100 bps for months 7 to 12. Draw 100 million in month 5 and 100 million in month 10. Pay OID of 1.5 percent on 500 million at close and 1.0 percent on each delayed-draw. Ticking fee outlay is roughly 750,000 dollars over the year, about 38 bps on the average delayed-draw balance. Lenders earn OID on both funded and drawn amounts, lifting IRR on committed capital.
Option value check: As a rule of thumb, if expected fee cost per year divided by expected average drawn amount is less than the expected market spread widening you avoid by pre-locking terms, the delayed-draw option pays for itself. In more uncertain pipelines, step-up ticking fees and later margin step-ups keep incentives aligned.
Documentation map and control levers
- Credit agreement: Define the delayed-draw facility, availability window, conditions precedent, use-of-proceeds, pricing, amortization, call protection, and cancellation rights.
- Fee letter: Spell out upfront fees, OID splits, ticking fee schedule, and step-up dates. Align dates with the credit agreement to the day.
- Security and guarantees: Use the same collateral and guarantors as the term loan. After-acquired property clauses and post-closing deliverables with realistic timelines help capture new subsidiaries and assets.
- Intercreditor alignment: If a revolver is present, confirm pro rata sharing and that mandatory prepayments and any call premiums apply proportionally across tranches.
- Incremental and MFN: Calibrate most-favored-nation protections and avoid cross-contamination of baskets to prevent arbitrage against the delayed-draw tranche.
- LCAs and reps: Limit LCAs to defined acquisitions. State which representations are tested at signing and which at funding, and tie ratio tests to funding.
- Information rights: Require pre-funding packages and a minimum review period for larger add-ons. Define materiality by enterprise value or EBITDA.
- Governance and enforcement: Favor objective funding conditions. Avoid subjective material adverse effect calls at funding. Keep default triggers crisp to preserve the right to refuse funding when conditions are not met.
Accounting, reporting, tax, and compliance
- Accounting: Under US GAAP, no liability exists until drawn. Fees and OID allocable to the delayed-draw are deferred, then recognized against the tranche when drawn and amortized to interest expense. Commitment fees are expensed over availability unless clearly tied to obtaining the financing, in which case defer and amortize after draw. Under IFRS, borrowers include origination fees in the initial carrying amount when drawn and amortize using the effective interest rate method. Lenders recognize expected credit losses on unfunded commitments under CECL or IFRS 9.
- Disclosure: Debt footnotes should show delayed-draw size, window, key conditions, and fees. MD and A should explain pipeline funding if material.
- Tax: US section 163(j) and UK Corporate Interest Restriction apply and OID amortization counts. Confirm portfolio interest or treaty relief for withholding. Some jurisdictions treat commitment fees as services subject to withholding, so draft gross-up and increased-costs clauses accordingly. Align transfer pricing if the delayed-draw funds cross-border add-ons.
- Compliance: Screen each target and its owners for KYC and sanctions. Banks hold capital against undrawn commitments under Basel rules. Private credit funds face portfolio and fund leverage constraints even if not subject to bank capital.
Key risks and practical guardrails
- Pipeline slip: Deals can lag, so the sponsor pays fees without scale gains and lenders stay exposed to a smaller business than modeled. Guardrail: shorter window, step-downs, and borrower cancel rights.
- Credit drift: Broad permitted acquisition terms can allow weaker assets or higher leverage. Guardrail: pro forma leverage caps, minimum EBITDA and quality standards, and covenant cushions no worse than at close.
- Event risk: The base business can soften before draw, making a draw unwise. Guardrail: leverage ratchets and minimum liquidity tested at each draw.
- Documentation leakage: Wide incremental and ratio-debt baskets can sidestep the delayed-draw. Guardrail: align baskets with intended seniority and prepayment sharing.
- Funding logistics: Lenders must fund on short notice and assignment limits reduce secondary solutions. Guardrail: pre-position liquidity and restrict transfers of undrawn commitments to approved lenders.
- Cross-border liens: New jurisdictions can strain perfection timelines. Guardrail: realistic post-closing periods, targeted opinions, or escrow until perfection.
Alternatives and when to use them
- Revolver: Best for working capital and seasonality. Not built for acquisitions due to borrowing-base tests and cash controls.
- Incremental capacity: Flexible but uncommitted, with pricing and terms that float with markets. Use for opportunistic or out-of-scope deals.
- Equity commitment letter: Highest certainty but dilutive to returns. Refinance later if conditions allow.
- Second-lien or holdco debt: For larger, higher-leverage add-ons, consider second-lien loans or holdco PIK solutions if senior capacity is tight.
Execution cadence that avoids friction
- Term sheet: Spend 1 to 2 weeks agreeing size, uses, window, conditions, and economics.
- Documentation and close: Plan 3 to 6 weeks for agreements, security, intercreditor, fee letter, and base-business diligence.
- Post-close setup: Finalize draw forms, account controls, cut-offs, and target diligence packages for threshold deals.
- Draw execution: Allow 1 to 2 weeks per acquisition to deliver notices, conditions, diligence, and funds flows while lenders update collateral schedules.
Common pitfalls and hard stops
- Frequent pitfalls: Windows longer than the real M and A timeline, vague permitted acquisition criteria, ticking fees too low for capital costs, misaligned call protection, and security gaps in new jurisdictions. Fix with tighter windows, hard criteria, step-up fees, pro rata call premiums, and pre-funding opinions or escrow.
- Hard stops: No credible pipeline covering at least half the ask, no pro forma leverage cap for draws, windows beyond 18 months without named targets, base business softening with tight covenants, or jurisdictions where perfection cannot be achieved within 60 to 90 days.
Extra discipline: practical drafting to preserve control
- Define permitted acquisitions: Add hard screens like minimum LTM EBITDA, positive EBITDA, no material litigation, approved jurisdictions, and rapid guarantor and pledge coverage.
- Use LCAs precisely: Specify which reps at signing and which at funding, and tie ratio tests to funding.
- Freeze baskets: State the delayed-draw funds only the uses set at close and does not expand other baskets.
- Pro forma deliverables: Require sources-and-uses, balance sheet, and covenant tests for larger draws with a defined review window.
- Information cadence: Quarterly pipeline updates with timing and status, with missed updates constituting a default.
- Price step-ups: Use date-certain schedules for ticking and margin step-ups and mirror them in the fee letter.
- Cancellation rights: Allow borrower cancellation to save fees and lender cancellation if a material covenant default runs past cure.
Where delayed-draw term loans fit best
- Speed and certainty: A delayed-draw wins when near-term add-ons are lined up and fixed terms beat market risk.
- Confidentiality: A bilateral or small club facility protects the pipeline better than a broadly syndicated incremental.
- Optics: Undrawn capacity does not inflate reported debt before closing acquisitions.
- Tax frictions: If withholding or local deductibility will bite on cross-border drawdowns, local debt or incremental at the target level may be cleaner.
Key takeaway
Use a delayed-draw term loan when the sponsor has a credible pipeline, a tight window, and the discipline to meet objective conditions to funding. Hardwire use-of-proceeds, pro forma leverage caps, and fee schedules that pay for undrawn capital. Keep the tool narrow and predictable. In financing, as in investing, pay for options you expect to use, and only as much as you need. For a deeper dive on buy-and-build use cases, see delayed-draw term loans in buy-and-builds.