When a company runs a proper process for a loan or credit facility, it usually ends up with two or three term sheets to choose between. Most owners and CFOs look at the interest rate first. That is understandable, since it is the number every lender leads with. But the rate is one line in a document that will shape how you run the business for several years, and the term sheet that looks cheapest on page one can turn out to be the hardest to live with.
This guide covers the terms we look at first when reviewing a debt term sheet, and a straightforward way to compare term sheets side by side.
Work out the all-in cost of each term sheet
Most business loans are priced as a base rate plus a margin, which lenders also call the spread. In the U.S. the base rate is usually SOFR or a bank's prime rate. In the UK it is typically SONIA or the Bank of England base rate. Two lenders quoting the same margin over different benchmarks are not offering the same price, so check which one each term sheet uses and whether there is a floor (a minimum level the base rate is treated as having, even if the market rate drops below it).
Then add the fees. The ones that come up most often are:
- Arrangement or upfront fee. Charged at closing as a percentage of the facility. Some private credit lenders take it as a discount to the amount funded, so you receive less than the face value of the loan.
- Commitment or unused fee. Charged on the undrawn part of a revolving facility or a delayed-draw term loan.
- Exit or prepayment fee. Payable if you repay early, and with some lenders payable at maturity whatever happens.
- Everything else. The lender's legal costs, which the borrower normally pays, plus agency, monitoring, valuation or field exam fees where they apply.
A rough way to make offers comparable is to spread the one-off fees over the period you actually expect to keep the loan. Take a hypothetical $10 million, five-year term loan, with numbers chosen only to keep the arithmetic easy. Lender A offers a 4.5% margin with a 1% arrangement fee. Lender B offers 4.0% with a 3% fee. Held for the full five years, A works out at roughly 4.7% a year and B at roughly 4.6%, so B edges it. If you expect to refinance after two years, the picture flips: A comes to about 5.0% and B to about 5.5%. This ignores amortization and compounding, but it is usually enough to show which way the decision leans.
Amortization and maturity shape your cash flow
Amortization is the principal you repay before the final maturity date. A loan with a lower rate and heavy scheduled repayments can take more cash out of the business each year than a pricier loan that is mostly repaid at the end. Look at the repayment profile year by year next to your forecast, and check for interest-only periods, balloon payments and any excess cash flow sweep, where a share of surplus cash goes to paying down the loan.
Maturity matters for a different reason. A three-year facility funding a five-year plan means you will be refinancing in the middle of it, on whatever terms the market offers at the time. A longer tenor costs something, and it is often worth it.
Covenants: maintenance, incurrence and headroom
Covenants are the promises you make to the lender, and the financial ones deserve the most attention.
Maintenance covenants are tested at regular intervals, often quarterly, whether or not you have done anything. Typical examples are a maximum leverage ratio, a minimum interest or fixed charge cover ratio, and a minimum cash balance. Incurrence covenants only apply when you take a particular action, such as borrowing more, paying a dividend or making an acquisition. Loans to owner-led and lower middle market companies usually carry at least one maintenance covenant, so the question becomes how much room you have.
That room is called headroom. If your forecast shows leverage of 2.5 times EBITDA and the covenant sits at 3.0 times, EBITDA could fall by about a sixth before you breach. Run your downside case through each lender's covenant package as well as your base case. Read the definitions closely too. How EBITDA is calculated, and which add-backs are allowed, can matter as much as the headline ratio. It is also worth asking what happens if you do breach, and whether the owners have the right to inject equity to cure it.
Security, guarantees and conditions precedent
Security is what the lender can take if the loan goes wrong. Some lenders want a lien over all assets, others are happy with specific receivables, inventory, equipment or property. Wider security can make it harder to raise other finance later, so note what each term sheet leaves free.
Guarantees need the same scrutiny. Many lenders to smaller companies ask for a personal guarantee from the owners. Whether it is capped, whether it falls away once the business hits certain targets, and whether it covers the whole facility are all negotiable points, and they differ a great deal between lenders.
Conditions precedent are what must happen before the money moves: due diligence, a quality of earnings report, valuations, final legal documents and, in many cases, the lender's credit committee approval. A term sheet that is still subject to credit committee carries less certainty than one that has already been through it.
Reporting, prepayment and what is actually binding
Every loan comes with reporting obligations. Expect some mix of monthly management accounts, quarterly compliance certificates and annual accounts, and for asset-based facilities a regular borrowing base certificate. If a lender requires audited accounts and you currently produce reviewed ones, that is a new annual cost and a new deadline for your finance team.
Prepayment flexibility matters most if there is any chance you will sell the business, refinance or pay the loan down from a large contract. Check the prepayment fees, the notice period and whether partial prepayments are allowed. Most facilities must be repaid on a change of control, so if a sale is on the horizon, a loan that is expensive to exit can cost you real money at the worst moment.
Finally, most term sheets do not commit the lender to lend. Certain clauses often are binding once signed, though, commonly exclusivity, confidentiality and an obligation to cover the lender's costs if the deal does not close. Have your counsel confirm which provisions bind you before you sign, especially the length of any exclusivity period.
A simple way to put term sheets side by side
You do not need a complex model. A single table and an honest forecast will do most of the work.
- List every term in rows and each lender in a column, using the same units throughout.
- Calculate the all-in cost over your expected holding period, which may be shorter than the stated term.
- Put your base case and downside case through each covenant package and record the headroom.
- Note the security, guarantees and conditions precedent for each term sheet in plain words.
- Mark each term as either acceptable as written or something you need to move, then go back to each lender with specific requests.
The term sheet stage is when you have the most bargaining power. Once you sign and grant exclusivity, it narrows quickly.
If it would help to have someone put your term sheets side by side and handle the negotiation with lenders, Kenward Partners does this work for owner-led and lower middle market companies in the U.S., UK, Europe, Canada and Australia. We are happy to look at what you have.
