What it means
Companies rarely know exactly how much funding they will need in two or three years. They might buy a competitor, open new sites or build stock for a growth spurt.
An accordion, sometimes called an incremental facility, gives them a route to extra borrowing on terms that were largely settled at the start. The feature is written into the original credit agreement.
It states the maximum extra amount, the conditions that must be met to use it and the pricing or the way pricing will be set. It is usually uncommitted, which means existing lenders are not forced to provide the extra money, although they often get the first chance to do so.
Using the accordion normally requires the borrower to meet certain tests, such as keeping leverage (debt compared with earnings) below an agreed level and not being in default. The borrower must also give notice and sign short supporting documents.
This is much quicker and cheaper than a new syndicated loan, which can take months of due diligence and legal work. For a finance team, an accordion is a form of financial flexibility.
It costs little or nothing to include when the loan is first arranged, though lenders may ask for a slightly higher margin or a fee. The value shows up later when an acquisition opportunity appears and funds can be arranged in days rather than months.
There are some important caveats. Because the extra money is generally not guaranteed, a business should not treat the accordion as cash it can count on in a crisis.
It is also worth remembering that drawing it increases debt, interest costs and risk, so the covenants (the promises made to lenders) still apply to the enlarged facility.
In practice
Real-world examples.
Example
A packaging company has a $100 million loan with a $30 million accordion. When it agrees to buy a smaller rival for $25 million, it draws on the accordion rather than arranging a new loan.
Example
A restaurant group plans to open 15 new sites over three years. It negotiates an accordion into its bank facility so that it can borrow more as each wave of openings proves successful.
Example
A software firm's accordion is unused when a downturn arrives. Because its leverage test is no longer met, the firm discovers the extra funding is not available when it would have been most useful.
Formula
Calculation
Formula: Maximum potential facility = Committed facility + Accordion amount. Leverage after drawing = (Existing debt + Accordion draw) / EBITDA. Extra annual interest = Accordion draw x Interest rate.
Worked example: a business has a $50,000,000 term loan with a $20,000,000 accordion. Its EBITDA (earnings before interest, tax, depreciation and amortisation) is $20,000,000. It draws $12,000,000 from the accordion at an interest rate of 6%.
Maximum potential facility = $50,000,000 + $20,000,000 = $70,000,000
Leverage before = $50,000,000 / $20,000,000 = 2.5x
Leverage after = ($50,000,000 + $12,000,000) / $20,000,000 = 3.1x
Extra annual interest = $12,000,000 x 6% = $720,000
If the lenders' leverage limit were 3.0x, this draw would not be allowed without more earnings or a smaller amount.Case study
Seen in the real world.
Cobalt Freight is a fictional logistics company used here as an illustrative example. When it arranged a $60 million loan to fund new trucks, the finance director asked for a $25 million accordion. The bank agreed in return for a small increase in the margin.
Eighteen months later, a regional rival came up for sale at a good price. Cobalt met the leverage test, gave notice, and had $18 million of extra funds within three weeks. A new standalone loan would probably have taken three months, by which time another buyer might have won the deal.
The finance director later reminded colleagues that the option had been available only because Cobalt kept its earnings healthy. The company still reviews its leverage each quarter to protect access.
Watch out
Common mistakes.
- Treating the accordion as guaranteed money. Most are uncommitted, and lenders can decline.
- Forgetting the conditions. Leverage tests and no-default clauses can block the draw when you need it.
- Overlooking the cost. Extra debt means extra interest, and the pricing on the accordion may be higher than on the original loan.
Questions
People also ask.
Why would a lender agree to an accordion?
It keeps the borrower within the same lending group and gives the lender a chance to earn more fees and interest. It also reduces the risk that the borrower moves to a competitor.
Is an accordion the same as a revolving credit facility?
No. A revolver lets you borrow, repay and borrow again within a fixed limit, while an accordion raises the size of the limit itself, subject to conditions.
Does the accordion appear on the balance sheet?
Only the part that has been drawn appears as debt. The unused portion is usually disclosed in the notes to the accounts.
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