What Is a Credit Facility, and How Does It Work?

What Is a Credit Facility?

A credit facility is a type of loan made in a business or corporate finance context. It allows the borrowing business to take out money over an extended period of time rather than reapplying for a loan each time it needs money. In effect, a credit facility lets a company take out an umbrella loan for generating capital over an extended period of time.

Various types of credit facilities include revolving loan facilities, committed facilities, letters of credit, and most retail credit accounts.

Key Takeaways

A credit facility is an agreement between a lender and a borrower that allows for greater flexibility than traditional loans.
Types of credit facilities include revolving loan facilities, retail credit facilities (like credit cards), committed facilities, letters of credit, and most retail credit accounts.
A credit facility often allows a company to have greater control over the amount and timing of debt, as well as the use of funds, than other types of lending agreements.
However, a credit facility usually comes with debt covenants, additional maintenance fees, withdrawal fees, and is more difficult to secure.
Credit facilities' terms and particulars, like those of credit cards or personal loans, are dependent on the financial condition of the borrowing business and its unique credit history.

Credit Facility — Investopedia / Michela Buttignol

How Credit Facilities Work

Credit facilities are used broadly across the financial market as a way to provide funding for different purposes. Companies frequently implement a credit facility in conjunction with closing a round of equity financing or raising money by selling shares of their stock. A key consideration for any company is how it will incorporate debt in its capital structure while considering the parameters of its equity financing.

The company may take out a credit facility based on collateral that may be sold or substituted without altering the terms of the original contract. The facility may apply to different projects or departments in the business and be distributed at the company’s discretion. The period for repaying the loan is flexible and, like other loans, depends on the credit situation of the business and how well it has paid off debts in the past.

The summary of a facility includes a brief discussion of the facility’s origin, the purpose of the loan, and how funds are distributed. Specific precedents on which the facility rests are included as well. For example, statements of collateral for secured loans or particular borrower responsibilities may be discussed.

A credit facility isn't debt. A credit facility gives the holder the right to demand loan funds in the future, and the borrower is only indebted when they draw on the credit facility.

Credit Facility Details

A credit facility agreement details the borrower’s responsibilities, loan warranties, lending amounts, interest rates, loan duration, default penalties, and repayment terms and conditions. The contract opens with the basic contact information for each of the parties involved, followed by a summary and definition of the credit facility itself.

Repayment Terms

The terms of interest payments, repayments, and loan maturity are detailed. They include the interest rates and date for repayment, if a term loan, or the minimum payment amount, and recurring payment dates, if a revolving loan. The agreement details whether interest rates may change and specifies the date on which the loan matures, if applicable.

Legal Provisions

The credit facility agreement addresses the legalities that may arise under specific loan conditions, such as a company defaulting on a loan payment or requesting a cancellation. The section details penalties the borrower faces in the event of a default and steps the borrower takes to remedy the default. A choice of law clause itemizes particular laws or jurisdictions consulted in case of future contract disputes.

Types of Credit Facilities

Credit facilities come in a variety of forms. Some of the most common include:

A retail credit facility is a method of financing—essentially, a type of loan or line of credit—used by retailers and real estate companies. Credit cards are a form of retail credit facility.

A revolving loan facility is a type of loan issued by a financial institution that gives the borrower the flexibility to draw down or withdraw, repay, and withdraw again. Essentially it's a line of credit, with a variable (fluctuating) interest rate.

A committed facility is a source for short- or long-term financing agreements in which the creditor is committed to providing a loan to a company—given the company meets specific requirements set forth by the lending institution. The funds are provided up to a maximum limit for a specified period and at an agreed interest rate. Term loans are a typical type of committed facility.

Note

A credit facility can either be classified as short-term or long-term. Short-term credit facilities often use inventory or operating receivables as collateral and have more favorable loan terms due to their short-term nature. Long-term credit facilities are more costly to compensate for risk, although they offer a company the greatest flexibility.

Pros and Cons of Credit Facilities

Credit facilities or other lines of credit offer tremendous flexibility for companies that aren't sure what their future credit needs will be. However, securing this type of line of credit may be difficult and expensive. Here are the advantages and disadvantages to a credit facility.

Pros

Provides a company financial flexibility
Strengthens the relationship between a financial institution and a company
Often increases the credit rating of a company
May require less administrative burden to secure future debt

Cons

Often results in added maintenance and withdrawal fees
May be difficult for younger or riskier companies to secure
Often requires a burdensome process to secure
May require additional administrative burden to maintain loan covenants

Pros of credit facilities explained

Provides a company financial flexibility: When a company wants to take out a traditional loan, it must often cite a specific reason, determine a specific amount, and identify a specific time frame for the debt to occur. Credit facilities are available upon demand or don't have to be used at all.
Strengthens the relationship between a financial institution and a company: A credit facility is also usually established between a company and financial institution that have a strong business relationship. By partnering with a bank (or syndicate of lenders), the company holding the credit facility may generate favorable terms with the lender.
Often increases the credit rating of a company: Companies that secure a credit facility may see a boost in their creditworthiness with other lenders.
May require less administrative burden to secure future debt: If the company wants to secure other debt or additional lines of credit, already having secured a credit facility potentially eases the administrative burden.

Though credit facilities are generally not used to support day-to-day operations and ensure a company's survival, a credit facility gives a company more resources to thrive operationally. Saving operating cash flow for strategic expansion allows the company to grow, while credit facility cash flow can be used for one-time or emergencies.

Note

A credit facility also bolsters a company's ability to remain solvent, should its business be cyclical or seasonal.

Cons of credit facilities explained

Often results in added maintenance and withdrawal fees: To compensate for the flexibility of a line of credit, a company must often pay additional fees for the debt. While lender fees vary from agreement to agreement, there may be monthly maintenance fees, annual administrative agency fees, and one-time setup fees to create the line of credit.
May be difficult for younger or riskier companies to secure: Lenders will want to see multiple years of business history and positive creditworthiness as part of the application.
Often requires a burdensome process to secure: The lender will often inspect a company's formation documents, organization structure, industry performance, cash flow projections, and tax returns. After pulling on a line of credit, the company is often entered into an installment plan agreement requiring ongoing maintenance.
May require additional administrative burden to maintain loan covenants: A company may experience extra administrative work with a credit facility. As part of the loan agreement, a company must often track and maintain financial covenants and disclose certain metrics as part of external financial reporting.

Credit Facility Example

In 2019, Tradeweb Markets collaborated with financial institutions to secure a $500 million revolving credit facility. Proceeds from the facility were intended to be used for general corporate purposes, and the lead legal arranger for the facility was Cahill Gordon & Reindel LLP. As of Dec. 31, 2022, Tradeweb Markets had drawn down $500 million with remaining availability of $499.5 million.

Due to the significant size of this credit facility, the indebtedness is with a syndicate of banks, with the lead administrative agent being Citibank, N.A. The credit agreement imposes a maximum total net leverage ratio and minimum cash interest coverage ratio requirement. Subject to satisfaction of certain conditions, Tradeweb Markets can increase the credit facility by an additional $250 million with consent from all syndicate lenders.

In the example, Tradeweb Markets also notes risks related to this indebtedness, including:

"The credit agreement that governs the Revolving Credit Facility imposes significant operating and financial restrictions on us and our restricted subsidiaries.
"Any borrowings under the Revolving Credit Facility will subject us to interest rate risk.
"The phase-out, replacement, or unavailability of LIBOR and/or other interest rate benchmarks could adversely affect our indebtedness."

What Are the Types of Credit Facilities?

There are several credit facilities a company can secure. A revolving loan facility allows a company to take out a loan, repay the loan, then use the same loan agreement again as long as there are principal funds available to borrow. A retail credit facility is often used to provide liquidity for cyclical companies that rely on inventory or high turnover of sales. A committed credit facility is a specifically negotiated set of terms that obligates a lender to lend money to a borrower, should the borrowing company meet specific criteria.

What Is the Difference Between a Loan and a Credit Facility?

A loan is often a more rigid agreement between a bank and a borrower. The borrower usually receives the funds upfront and then repays it with interest. A credit facility is more flexible, as the agreement allows a borrower to take on debt only when they need the funds.

What Is a Credit Card Facility?

A credit card facility is different than a credit facility. The term credit card facility is often used to describe features of a credit card that a cardholder receives when a credit card is opened. For example, a credit card may come with technology allowing for transactions to be automatically paid, split into tracking categories, or transferred to other cards.

Is Credit Facility Used in Debt?

A credit facility is a way for a company to take on debt. It's an agreement between a company and a lender that, should the company need funds, it can draw on the facility and borrow money. Just because a company has a credit facility doesn't mean it has incurred debt. A credit facility simply grants the company the right to take on loan funds.

The Bottom Line

A credit facility is an agreement between a lender and a borrower that allows for greater flexibility than traditional loans. Types of these include revolving loan facilities, retail credit facilities (like credit cards), committed facilities, letters of credit, and most retail credit accounts. A credit facility often allows a company more control over the amount and timing of debt, as well as the use of funds, than other types of lending agreements.

On the downside, a credit facility usually comes with debt covenants, additional maintenance fees, withdrawal fees, and is more difficult to secure. Credit facilities' terms and particulars, as with most loans, depend on the financial condition of the borrowing company and its credit history.