What Are Debt Accordions?
A debt accordion, also known as an incremental facility, is a provision that allows a borrower to expand the maximum amount allowed on a line of credit (LOC), or to add a term loan to an existing credit agreement.
- Debt accordions are provisions that allow a borrower to increase the maximum allowed on a credit line or add a term loan to it.
- The interest rate on the extended credit, along with most other terms, often remains the same as on the original credit line.
- Debt accordions will limit the total amount that can be borrowed and any new borrowing will be contingent on the company complying with its existing financial covenants.
- Companies may purchase an accordion agreement if they anticipate capital needs in the future but are unsure if and when those funds will actually be required.
Understanding Debt Accordions
Debt accordions, like the portable, box-shaped musical instruments they are named after, can be pulled and stretched to lengthen in size as needed, creating flexibility for borrowers.
The option to increase a loan term or credit amount with a financial lender is most often offered on commercial accounts and generally stipulated within the existing terms of a credit agreement already in place. Typically, the interest rate, the amount charged for borrowing money, and other terms will remain the same as on the original credit line or loan agreement.
Companies commonly include an accordion agreement, which comes at extra cost to the borrower, if they anticipate needing additional capital to fund expansion plans in the future but where the timing remains uncertain. The extra funds may be used to acquire other businesses, to boost working capital, the money available to fund a company’s day-to-day operations, or to meet other needs.
Credit increases are optional, meaning that companies privy to this arrangement are not obligated to take on additional debt.
Usually, these facilities will feature a cap limiting the total amount that can be borrowed and the maximum number of times it can be used. Some lenders, however, will provide more flexible arrangements and may even offer unlimited debt accordions, depending on the profile of the borrower. Accordion features have become increasingly prevalent in the leveraged loan market.
Debt Accordion Requirements
These types of loans generally have several conditions attached, including a maximum amount of total incremental debt the company can take on and a cap on the number of times the incremental facility may be used.
Frequently, each increment, or increase, is contingent on the company or borrower complying with existing financial covenants and potentially hitting certain targets. All expectations are negotiated at the onset, during which a pro forma plan is agreed upon by all parties.
Benefits of Debt Accordions
Debt accordions are simple and cost-effective. They do not require a new loan agreement, making it easy for corporate borrowers to gain relatively quick access to funds if and when they need them.
The timeliness of funds can be critical in some environments. For instance, a company that’s a desirable acquisition target might be quickly snapped up by a competitor if funds are not readily available.
Debt accordions can particularly come in handy for up-and-coming startups with a novel and innovative idea or product. Making additional credit increases contingent on the business exceeding pro forma expectations gives financial institutions (FIs) some peace of mind, ensuring more of them are willing to extend credit to a company that would otherwise be deemed too risky to lend to.
Meanwhile, with this source of revolving capital, the company can get quick access to the funds it needs to capitalize on its potential when and where opportunities present themselves. Taking time to rehash credit terms may be counterproductive and give competitors the chance to seize the opportunity.