Term loan vs line of credit

A buyer arranging acquisition financing usually ends up with both a term loan and a line of credit in the same package, and confusing what each one is for is a common early mistake. They are structured for different jobs: one pays a single large amount once, the other is a flexible tap a business turns on and off as its cash needs shift through the year.

Term loan

A term loan advances the full approved amount in one lump sum at closing, then is repaid on a fixed amortization schedule over an agreed term, with interest accruing on the declining balance as principal is paid down. It is the facility that actually funds an acquisition, because a purchase price is a one-time obligation, not a recurring, fluctuating need — the buyer needs a defined amount on a specific closing date, not an open-ended tap. Once advanced, the schedule is generally fixed, and prepayment terms, if any, are set out in the loan agreement rather than negotiated informally after the fact.

• One lump-sum advance, typically drawn in full at closing to fund the purchase price
• Repaid on a fixed amortization schedule agreed at the outset, not redrawn once repaid
• Interest accrues on the outstanding balance, which declines as scheduled payments are made
• The natural facility for a one-time obligation like an acquisition, rather than for ongoing operating needs

Line of credit

A line of credit sets an approved limit the business can draw against, repay, and draw against again, as many times as needed, with interest charged only on the amount actually outstanding at any given time. It exists to smooth out the normal timing gaps in a business’s cash flow — paying suppliers before customers pay their own invoices, covering a seasonal slow stretch, or funding inventory ahead of a busy season — rather than to fund a one-time purchase. Lenders often size a line of credit against a borrowing base tied to receivables and inventory, and they typically review or renew the facility periodically rather than setting a fixed end date the way a term loan has.

• Revolving: can be drawn, repaid and redrawn repeatedly up to an approved limit
• Interest applies only to the amount actually drawn, not the full approved limit
• Sized and monitored against short-term assets such as receivables and inventory in many cases
• Reviewed or renewed periodically by the lender, rather than running on a fixed amortization to zero

How to choose

This is rarely an either-or decision for a buyer financing an acquisition — the term loan is what actually pays the seller at closing, and a line of credit alongside it is what keeps the business from running short of cash in its first months under new ownership, when the timing of receivables and payables is often less predictable than it will become later. A buyer who arranges only a term loan and skips the operating line frequently discovers the gap the hard way, in the weeks after closing when working capital is tightest and least forgiving. Lenders generally expect to see both requested together as part of a single financing package, sized against the specific business’s cash conversion cycle rather than a generic rule.