Understanding the Real Cost of Debt Facility

It’s no secret – raising a debt facility can be a challenging task for fintech founders. Perhaps the biggest challenge, and what many fail to understand – is the actual cost associated with it. 

The investors and expenses related to a substantial facility can have a long-lasting impact on the company’s trajectory. That’s why a cautious and well-thought-out approach to debt facilities is essential to avoid mistakes.

Unfortunately, most founders just don’t understand the actual cost of capital when negotiating a term sheet. Debt facilities involve important variables, such as interest rate, initial setup expenses, ongoing compliance costs, and more. And much of that web of expenses is paid for upfront and by the startup, even before using the facility.

It’s not uncommon for founders to feel surprised (even overwhelmed) by the upfront costs of a debt facility. These expenses can be daunting, and first-time borrowers may experience sticker shock. In this article, we’ll guide you through the different upfront costs that are associated with a debt deal, as well as the components of a facility that determine these costs.

Debt Facility Upfront Costs

Every debt deal has associated costs and some of those costs are paid for by the investor and some are paid for by the startup before the deal is even signed. Here are some of the important upfront costs founds should know about: 

Initial Committed Amount: When obtaining a facility, only a portion of the total facility is initially committed. This means that the lender will provide funding for at least the committed amount of the facility. For instance, if a facility has a total amount of $50 million, the initial committed amount may be $10 million. If loans don’t perform, the facility may be discontinued after this committed amount. Hence, it is crucial to anticipate how much of the facility you expect to use.

Structuring Fee: Banks commonly charge an upfront fee, expressed as a percentage of the committed amount rather than the overall facility amount when concluding a transaction. Later on, when the next tranche is committed, they’ll charge a fee on the additional committed amount.

London Interbank Offered Rate (LIBOR): LIBOR is a benchmark interest rate used by major global banks to lend to one another. A facility’s interest rate is set based on the standard 30-day LIBOR.

Benchmark Floor: Interest rates are set using LIBOR or a similar base rate. However, if the LIBOR is too low, banks may establish a floor rate, usually 25 basis points (bps) or higher.

Interest Spread: The interest spread is the interest rate added to a benchmark floor rate charged on the outstanding balance, where (Benchmark Rate + Interest Spread = Interest Rate).

Unused Fee: A fee charged on the committed amount not yet deployed, starting on day one after the facility begins. You will continue to pay this fee until the facility is fully deployed, starting at 0.25% of the amount not deployed.

Agent Fee: A lender may assign an agent who works on their behalf, charging a monthly fee to manage a small part of the lender’s operations regardless of the deployed amount.

Ongoing Diligence Fee: After obtaining a facility, you will pay an annual fee for ongoing due diligence, including financial audits, loan audits, compliance reviews, and other similar items. In some cases, lenders may require a biannual review.

Facility Set Up Costs: This is, by far, the most expensive of all the upfront costs. It includes lawyer fees (both yours and the lender’s), audit fees, an initial compliance review fee, a loan audit fee, background check fees, travel expenses for on-site visits by the lender’s team, and other items.

Default Margin: If your company goes into default under the events of default condition, lenders charge an additional rate on top of the interest rate, which generally ranges from 1% to 3%. It’s important to note that you won’t pay this additional rate during normal operations.

Putting It All Together

Now, let’s take a look at an example of how debt facility fees play out. Note, though, that the example below also includes fees beyond the upfront fees, for the sake of completeness.

In a typical debt facility, fees will play out as follows:

When you secure a debt facility, only a portion of the total facility is committed at the outset. This means the lender will only fund the committed amount, such as $10M of a $50M facility. If the loans don’t perform, the facility may be discontinued after this initial committed amount. Therefore, it’s crucial to anticipate how much of the facility you expect to use.

If your investor is a bank, it’s common for your bank to charge an upfront structuring fee as a percentage of the committed amount, rather than the overall facility amount. They may also charge a fee on the next tranche of committed funds at a later stage.

The facility’s interest rate is based on the standard 30-day LIBOR, which is the benchmark interest rate at which major global banks lend to one another. But, as mentioned above, if LIBOR is too low, banks set a benchmark floor rate, usually starting at 25 basis points.

The interest spread, then,  is the interest rate charged on the outstanding balance on top of the benchmark floor rate (benchmark rate + interest spread = interest rate).

An unused fee is charged on the committed amount not yet deployed, starting on day one after the facility begins. You will continue to pay this fee until the facility is fully deployed, starting at 0.25% of the amount not deployed.

The lender may assign an agent who works on their behalf, charging a monthly fee to manage a small part of the lender’s operations regardless of the deployed amount.

After securing a facility, you will pay an annual fee for ongoing due diligence, including financial audits, loan audits, compliance reviews, and other similar items. In some cases, lenders may require a biannual review.

The facility setup costs are the most expensive of all upfront costs, covering lawyer fees, both yours and the lender’s, audit fees, initial compliance review fees, loan audit fees, background check fees, travel expenses for on-site visits by the lender’s team, and other items.

If your company goes into default under the events of default condition, lenders charge an additional rate on top of the interest rate, usually ranging from 1% to 3%. As noted above, you won’t pay this additional rate during normal operations.

Final Thoughts

Raising a debt facility can be a crucial step for fintech startups, but perhaps even more important is understanding the actual cost associated with it. The upfront costs of a debt deal can be daunting, and many founders fail to anticipate the various expenses that come with it. These include structuring fees, interest spreads, agent fees, and more 

To avoid mistakes, fintech founders must be cautious and take a well-thought-out approach to debt facilities. Armed with the information above, you’ll be able to more confidently anticipate the fees of your next debt deal and avoid the all-too-common sticker shock many founders experience.

Frank Gogol

A seasoned SEO expert, Frank has a long history of working with and for startups. Starting in mid-2018, Frank served as the SEO Strategist for Stilt, a fintech startup that provided fair loans for immigrants in the US and other underserved markets. While with the company, he scaled site traffic from zero to more than 1.5 million unique visits per month, driving the bulk of the company’s lead generation until it was acquired by J.G. Wentworth in December 2022. As employee #5 at Stilt, Frank was witness to, and part of, the successful building and sale of a fintech company, uniquely positioning him to create content for founders about all things startups.

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