A guide to important terms in a debt term sheet

The number of fintech startups is growing quickly. Since the pandemic, all areas of financial services are being rebuilt for consumers and businesses. But growing credit businesses require debt capital. And raising debt is not commonly talked about or discussed in the public domain. Talking to many founders, I realized there aren’t good resources available and founders are shooting in the dark.

Since we started Stilt, we have negotiated $750M in debt facilities and closed $225M+ over the last few years. In my previous post, I discussed raising debt capital at various stages of your startup.

This is part 1 of upcoming debt term sheet posts. In this post, I’ll share key terms of a debt facility term sheet. In future posts, I will discuss negotiations, what’s important, and sneaky terms to look out for.

The following terms generally apply to 2 types of debt facilities — forward flow and warehouse/revolving.

Forward Flow facility:
A facility where you sell the loans (generally, at par*) to a debt provider after they are originated. This is not a revolving facility. Once the facility is used, the loan repayments can’t be used to lend again. The originator (your startup) gets to keep the origination fee and earns a servicing fee. In most cases, the facility provider will keep the economics from the loans.

*at par = price paid for the loans sold equals the cost of the loan (at the time of sale) — it includes outstanding principal and remaining interest

Warehouse/Revolving Facility:
A facility where the debt provider will fund against a pool of loans originated by the platform. In a revolving facility, loan repayments replenish the outstanding facility balance. So, this facility amount can be rotated multiple times (depending on the duration of the portfolio). Generally, warehouse facilities are lower cost, have stringent requirements, and lead to securitizations down the line.

A few things to note about raising debt capital:

  • Debt is a fixed-income asset (as opposed to equity). The lenders want predictable and consistent cash flows every month. They earn a maximum X% return if everything goes well (there is no 100x upside), so they are cautious.

Let’s get into the key terms:

  • Interest Rate — the most important term in the facility. This is the interest rate you expect to pay on the outstanding principal balance. The interest is calculated daily (360 or 365 days) and paid weekly, biweekly, or monthly depending on the waterfall (explained below).

Diligence items: The lender goes through their internal due diligence list for each function of the parent company. Below are the common functions they’ll go through in detail:

  • Technology — to understand the technology built to originate and manage loans. Also includes security and other tech infrastructure items.

Audits: The lenders may ask for a third party loan portfolio audit (common in later stage facilities). This is generally done by an investment bank or an auditor who specializes in this. The lender wants to make sure that the loans were actually disbursed to real borrowers, loans were transferred to the correct accounts, repayments were applied correctly, and the balances were correctly updated.

This audit is different from a company audit which focuses on the overall financials of the parent company.

As you negotiate terms with a lender, it helps to understand these terms. There are a lot more terms to consider when you are actually closing a facility but the list above should be good enough for the most part. The more informed you are when negotiating the term sheet, the easier your life will be in the actual closing process.

Hope this is helpful in understanding a debt facility term sheet. I’ll share thoughts on negotiations in my next post.

I am always around for discussions. Feel free to follow me or send me a note on twitter @rohitdotmittal.

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