Term Loans vs. Revolving Credit: Which Is Right for Your Business?

For startups and growing companies alike, understanding the nuances between different financing instruments can mean the difference between strategic growth and financial strain.

Term loans, designed for large capital expenditures and acquisitions, offer predictable repayment schedules over 3 to 7 years. Revolving credit, on the other hand, provides flexible access to funds for day-to-day operations, though typically at higher interest rates.

What are term loans?

Term loans are a form of lump-sum credit that must be repaid over an agreed-upon period. Since a business can receive significant funds through term loans, these loans are typically used for large expenditures, such as capital expenditure or funding acquisitions.

Term loans can be broadly categorized as loans secured against collateral assets and ones that are not secured against any collateral. From the lender’s perspective, secured term loans are less risky and hence, attract lower interest rates than unsecured term loans.

Startups may find it challenging to secure term loans from traditional lenders since they are perceived as high-risk businesses that burn cash to develop pre-validation products and capture market share.

To address the unfulfilled debt needs of startups, venture debt was introduced. A venture-backed startup can raise venture debt ranging from 20% to 40% of its previous equity round. Such loans have terms of 3 to 4 years and come with an interest-only period of 6 to 12 months.

When are term loans suitable for your business?

You can use term loans for the following business objectives:

Business expansion

Term loans allow companies to make upfront capital commitments for large investments such as the establishment of new production facilities and geographic expansion. These loans have long repayment schedules and businesses find it easier to match the cash flow generated f with the monthly installments.

For instance, a Texan energy company can take a 7-year loan for oil exploration and drilling in New Mexico. The company may need to initially rely on existing cash flows and reserves to keep up with the repayments. But, eventually, the cash flows generated by the New Mexico facilities may cover the debt repayments.

Acquisitions

Leveraged buyouts (LBOs) have become a common acquisition deal structure wherein funding is partially or fully secured through debt. Here, the returns generated from the investment/acquisition are divided between the acquirer’s shareholders and the lenders. But the lenders’ return is limited to the interest. The rest of the returns are fully captured by the acquirer’s shareholders. Essentially, using term loans to acquire targets with high growth potential allows acquirers to make outsized returns.

Refinancing

Refinancing involves replacing existing debt obligations with a new loan, typically with a more favorable interest rate. If your business has multiple short-term, high-interest debt obligations, replacing them with a long-term loan can reduce interest expenses and improve working capital efficiency.

One example of refinancing would be when Caterpillar issued bonds carrying an interest of 1.9% in 2021 to redeem all of its existing 2.6% notes.

What is revolving credit?

Revolving credit allows businesses to borrow funds as and when required, up to a certain limit and it is an accessible way to build a credit history. Examples of revolving credit include credit cards and lines of credit (LOC). Revolving credit provides much faster access to credit than term loans since the credit is pre-approved by the lender. However, revolving credit typically carries a significantly higher interest rate.

To access revolving credit at lower interest rates and with higher limits, you should consider lines of credit secured with collateral.

Repayment terms for revolving credit vary from lender to lender and product to product. But, with most forms of revolving credit, you need to make monthly payments of principal and interest over a fixed monthly schedule, and as you repay, the credit limit is replenished.

When is revolving credit right for your business?

Revolving credit, which is designed to support the day-to-day functioning of businesses, can be used in the following manner:

Working capital needs

Lines of credit allow companies to draw funds as required, repay them whenever sufficient cash reserves are accumulated, and reuse the facility without renegotiation. For instance, you can rely on a line of credit to service new orders when you have already exhausted cash reserves trying to fulfil previous orders.

This facility can also be used for meeting payroll and other recurring expenses when payments are delayed. In the retail industry, it is not uncommon for businesses to use lines of credit to bridge the gap between inventory, expected demand, and conversion cycles.

Autonomous employee expenses

Employees sometimes face expenses that cannot be delayed until approved by their manager. For instance, at the Ritz-Carlton, frontline employees can spend up to $2,000 per incident to assist customers, without seeking approval. This allows Ritz-Carlton employees to swiftly elevate guest experience.

Similar autonomy over business expenses can help employees in other customer-facing roles. For instance, a sales professional trying to close an enterprise client may need to host contact persons for dinners and drinks. Extending such autonomy becomes straightforward with business credit cards that have built-in per-transaction and periodic limits.

Key Differences Between Term Loans and Revolving Credit

Here’s a summary of how term loans and revolving credit differ:

Feature	Term loans	Revolving credit
Disbursement	Lump sum upfront	Draw funds as and when required, up to the credit limit
Repayment structure	Fixed monthly instalments of principal and interest over the agreed period	Monthly payments with a credit limit replenished as you repay
Typical term length	3-7 years (venture debt: 3-4 years)	Ongoing facility with periodic renewal
Interest rate	Lower, especially for secured loans	Significantly higher than term loans
Approval speed	Slower, requires an underwriting process	Much faster access since credit is pre-approved
Collateral requirements	May be secured or unsecured Secured loans attract lower rates	Can be secured or unsecured Secured facilities offer lower rates and higher limits
Best used for	Large capital expenditures, acquisitions, business expansion, and refinancing	Working capital needs, recurring expenses, bridging cash flow gaps, and autonomous employee expenses
Interest-only period	Available (6-12 months for venture debt)	Not applicable
Flexibility	Low - fixed repayment schedule	High - borrow and repay as needed without renegotiation
Credit building	Improves credit with consistent payments	Often seen as an accessible way to build credit history

Eqvista – Your Partner in Strategic Financial Planning!

Utilizing term loans and revolving credit in the right manner is a critical piece of your broader financial puzzle. To access either form of funding, you must demonstrate your creditworthiness to potential lenders.

Startups in particular face an uphill battle and hence must leave no stone unturned when it comes to displaying financial discipline and sustainable growth.

Eqvista’s cap table platform enables you to manage equity effectively and share clear, accurate representations of your ownership structure and valuation history with potential lenders, helping you secure favorable terms without triggering red flags. Through our partnership with Cheqly, we’ve also streamlined access to venture debt for startups. Contact us today to learn how Eqvista can support your debt financing journey!