What is a credit agreement?
A credit agreement is a legally binding contract between a lender and a borrower that spells out all the details and rules of a loan. In the context of debt capital, or the type of loans that fintechs and other high-growth companies rely on for expansion, credit agreements lay out all the key terms of a loan, including how much the loan is for, what the interest rate on the loan is, and what rules borrowers have to follow in order to maintain full access to their debt capital.
In our previous posts on topics ranging from fintech cash flows to debt covenants, we've covered the types of compliance issues that startup borrowers should think about when they want to make the most of debt capital. In other words, we've talked about how corporate borrowers can use the rules of their credit agreement to their advantage. But we've never gone into where those rules come from. In this post, we'll explain the source of truth for those rules: the credit agreement.
How does a credit agreement work?
It's not uncommon for credit agreements to run into the hundreds of pages (here's an example we've used in the past), and to seem needlessly complex.
But dive into the mechanics of a revolving credit facility and you'll quickly see why this extremely high level of detail is necessary. Credit agreements don't just spell out the high-level terms of a loan; they also serve as a roadmap for almost all the financial operations of revolving credit facilities (the kind fintechs and other companies use to fuel their growth) over the course of several years. In that sense, credit agreements are the instruction manuals for fintechs and other borrowers looking to make the most of their loan.
Credit agreements indicate, for example, how often borrowers have to report on their assets and financials, what form those reports should take, what types of insurance they have to maintain, and what third-party vendors will verify the accuracy of that data. Loan agreements also indicate what borrowers can't do during the life of the loan: take out additional debt, for example.
And that's just for when things are running smoothly. Should a borrower experience significant business changes (a change in leadership, for instance), a thorough credit agreement will spell out whether the loan is still valid, as well as how long a borrower has to report the change(s) to its capital provider.
What are common sections in credit agreements?
While no two credit agreements are identical, most fintech credit agreements will cover the following key areas, at minimum:
Nature of the loan. A credit agreement will spell out whether the facility is committed or uncommitted, secured or unsecured (i.e., backed by collateral or not), the amount of a loan, the duration of the loan, and the interest of the loan.
Rules of the loan. Credit agreements often contain covenants, or rules that borrowers have to follow in order to maintain access to their loan. Examples include the frequency and conditions of borrower draw requests.
Definitions. Nearly all credit agreements will have a long section that carefully defines the key terms of the credit agreement, including accounting terms, key applicable laws or benchmark rates, and key vendors. This section ensures that neither side misinterprets the obligations of the credit agreement.
Payment mechanics and conditions. Credit agreements will detail things like how often fintech borrowers should pay interest on their loan (and how that interest should be calculated), how fintech borrowers might pay third-party vendors, and other fees that might be associated with the credit agreement.
Contingency plans. When borrowers miss payments or breach covenants, they trigger events of default, which allow lenders to ask for full repayment. At the same time, credit agreements often outline a grace period during which a borrower can rectify a mistake, breach of rules, or missed payment without triggering an event of default.
What are examples of credit agreements in fintech?
Fintech credit agreements are often for revolving credit facilities, especially asset-backed facilities. The most important terms in fintech credit agreements tend to focus on the quality of a fintech's asset portfolio.
It makes sense that capital providers would be more willing to extend credit to fintechs with high-performing portfolios than fintechs with portfolios that have underperforming or risky assets. Capital providers want to minimize their own risk exposure, but they also want to offer terms that are attractive to borrowers.
Credit agreements (and the negotiations that lead up to the execution of credit agreements) reflect that fundamental motivation: full access to credit in the ideal case, and the gradual tightening of credit should a fintech borrower's assets worsen in performance, usually through mechanisms like eligibility criteria, concentration limits, and advance rates.
While credit agreements are bilateral agreements and not made available to the public, there's always a credit agreement in the background when you read about leading startups successfully raising and managing debt.
Want to learn more?
In the past, companies have had to track all the covenants and stipulations of credit agreements manually, a process that's been both error-prone and labor-intensive. Today, innovative startups like Ramp, Even, and Ribbon are ensuring programmatic credit agreement monitoring and management by using Finley's debt capital management software to monitor the covenant tracking and reporting for their credit facilities.
If you're interested in learning more about software that can help you scale your capital markets function and ensure debt capital compliance, just request a consultation with a Finley debt capital expert and we'll be in touch!