What Is an Accordion Feature?
An accordion feature is an option that a company can buy that gives it the right to increase its line of credit (or similar type of liability) with a lender. Companies typically purchase an accordion feature in anticipation of the need for more working capital for possible expansion opportunities. If such opportunities do to materialize, the option can be left to expire without penalty.
- An accordion feature in a line of credit allows a business to increase that line of credit if necessary, often to obtain more working capital or emergency cash.
- The accordion feature is an added option that requires the business to pay a premium for the right to use it.
- If the feature is not exercised, the company faces no penalty, but will lose out what it paid to purchase the option.
Understanding Accordion Features
The accordion feature creates a positive benefit for all parties involved in a loan agreement. Loan terms with an accordion feature are well suited for situations where a business shows great potential for accelerated growth, while at the same time there are indications of risks from uncertainty due to factors for which the business has no control. A lender is able to somewhat mitigate the risk of the noted uncertainty by increasing a line of credit incrementally, with each increment made contingent on the future realization by the business of specific predetermined expectations, and an increased certainty of the aforementioned uncontrollable factors. All the expectations are negotiated and a pro forma plan is agreed upon by all parties.
For businesses, most notably a business with a novel and innovative idea or product, the accordion feature is beneficial in several ways. First, it allows the business to put forth more favorable terms for lenders. This serves to attract more lenders to businesses seeking credit that would otherwise be deemed as too risky. By making additional credit increases contingent on the business exceeding pro forma expectations, the lenders focus more on the opportunity than the risk. Second, the terms for the entire line of credit, including all the incremental increases, are negotiated at the onset. Thus, if and when a credit increase takes place, all the terms are predetermined, and the credit increase can be expedited. This is especially important for the new business that has exceeded its expectations, and rapid expansion may be warranted to capitalize on untapped markets before competitors seize the opportunity. Taking time to rehash credit terms may be counterproductive.
Another important characteristic of the accordion feature that benefits the business is the credit increases are optional. Consequently, if the business can expand without incurring additional debt, it can make that decision.
Example of An Accordion Feature
For example, suppose company ABC has established a $100,000 line of credit with the Bank of XYZ. Company ABC has also purchased an "accordion feature" that lets it increase its total debt commitment of $100,000 to $150,000 because Company ABC believes it will need an additional $50,000 if it decides to add a new sales division. This term's origin is derived from how an accordion can be pulled and stretched in a manner that lengthens its total size.