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 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 not materialize, the option can be left to expire without penalty.
- An accordion feature in a line of credit allows a business to increase its 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 option can be left to expire without penalty.
Understanding Accordion Features
The accordion feature creates a 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, even though there are indications of risks of uncertainty due to factors for which the business has no control.
A lender can mitigate the risk of uncertainty by increasing a line of credit incrementally, each increment contingent on the future realization by the business of predetermined expectations. All the expectations are negotiated and a pro forma plan is agreed upon by all parties.
For a business with a novel and innovative idea or product, the accordion feature is beneficial in several ways. It allows the business to entice more favorable terms from lenders, and 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.
Additionally, the terms for the line of credit, including all the incremental increases, are negotiated at the onset. If and when a credit increase takes place, all the terms have been predetermined, and the credit increase can be expedited. This is essential for a new business that has exceeded its expectations, and rapid expansion is warranted to capitalize on an opportunity.
The accordion feature benefits the business as credit increases are optional.
Example of an Accordion Feature
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 from $100,000 to $150,000 if and when Company ABC believes it will need an additional $50,000 to add a new sales division. If the company can expand with the additional debt, the accordion feature is optional and can be left to expire without penalty