Bullet Loan

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Arc Team

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What are bullet loans?

Bullet loans are a unique type of debt financing where rather than making monthly payments that go towards the principal of the loan, the borrower either makes no monthly payments or interest-only monthly payments for the life of the loan. At the end of the loan term, they make a single payment to satisfy the principal and interest repayment.

In what scenarios do startups typically use a bullet loan?

Bullet loans are used in a variety of situations, but most commonly it is used by startups who do not want high fixed monthly payments which can drag down their cash flow or startups who need the additional capital to satisfy their operating expenses for the length of the term loan. They operate under the premise that they will be able to repay the principal / interest in the future, but not today. Bullet loans are also sometimes used as a form of bridge financing to satisfy the operating expense requirements of a startup that is raising equity capital, or when the startup is pursuing an acquisition.

In what scenarios should startups avoid using a bullet loan?

There are a few scenarios in which a startup should avoid using a bullet loan including when:

  • They’re not confident that they’ll be able to satisfy the principal (and interest) at the end of the loan term. 
  • They don't have a clear strategy for using the funds.
  • They are eligible for other forms of financing with a lower interest rate.

Can you provide an example of a bullet loan in action?

Suppose a borrower takes out a bullet loan of $100,000 with a five-year term and a fixed interest rate of 5%. The borrower is not required to make payments during the five-year term, so they decide not to. At the end of the term, they would be responsible for paying off the entire loan amount, plus any accrued interest.

In this example, the borrower would need to come up with $127,628  to pay off the loan at the end of the five-year term. If they're unable to do so, they would either refinance the loan into a new one with fixed payments, or try to negotiate an extension to the term of the bullet loan.

How do I amortize a bullet loan?

A bullet loan amortization schedule is different from typical amortization schedules because it may not include payments during the loan term. Instead, the entire balance (principal + interest) is due at the end of the term.

To amortize a bullet loan, you'll need to calculate the interest accrued over the loan term. You can use an online calculator or do the math yourself using the following formula:

  • Year 1: Interest = Principal x (1 + Interest Rate)
  • Year 2: (Principal + Interest Year 1) x (1 + Interest Rate)
  • Year 3: (Principal + Interest Year 1 + Interest Year 2) x (1 + Interest Rate)

For example, if you receive a bullet loan of $100,000 with a fixed interest rate of 5% and a five-year term, the interest accrued would be $27,628. The borrower would owe the entire loan amount of $127,628 at the end of the five years.

What are the advantages of raising capital via bullet loans? 

There are a few advantages of raising capital via bullet loans.

  • It can be easier to qualify for a bullet loan than other types of loans. This is because lenders only need to evaluate the borrower's ability to repay the loan at the end of the term rather than their current financial situation.
  • Bullet loans can provide startups with the capital they need to quickly grow their business. This can be especially helpful for startups that are seeking venture capital.
  • Bullet loans offer higher flexibility than other types of loans. This is because borrowers can choose to make interest-only payments, or no monthly payments at all, which can help them conserve cash when they need it most.

What are the disadvantages of raising capital via bullet loans? 

There are a few disadvantages of raising capital via bullet loans. 

  • The interest rate on a bullet loan may be higher than other types of loans. This is because lenders are taking on more risk by lending to a borrower that will not immediately start repaying them. 
  • They may put a strain on cash flow if interest-only payments are required.

Common pitfalls to avoid when taking a bullet loan?

There are a handful of pitfalls to avoid when taking a bullet loan, the most important is avoid taking more money than you need. It can be tempting to take more (especially if they’re offering 2-3x more), but you’ll either be paying for capital you don’t use (best case), or you’ll likely spend it without generating ROI-positive results (worst case). Ultimately, before taking on a bullet loan, it's crucial that you understand what the use of funds is and how much you actually need—then give yourself a bit of wiggle room (5-10%).

What are the typical terms of a bullet loan?

Several terms are typically associated with bullet loans. These include:

  • Balloon payment: This is the lump sum payment that is made at the end of the loan term. It is typically equal to the entire principal of the loan plus interest.
  • Interest-only payments: These optional payments are made during the life of the loan, they cover the interest that accrues on the principal. 
  • Maturity date: This is the date on which the loan principal (plus interest) must be repaid. It is typically set for two to five years after the loan is originated.

Can you negotiate the terms of a bullet loan? 

Yes, it is definitely possible to negotiate the terms of a bullet loan. The most commonly negotiated terms of a bullet loan are the interest rate, repayment schedule, and the requirement of interest-only payments. Consider getting 2-3 offers before making a decision on which offer you will accept.

What are the financing alternatives to bullet loans?

There are a few financing alternatives to bullet loans. These include:

  • Fixed-rate loans: Fixed-rate loans have interest rates that are set for the life of the loan. They provide borrowers with stability and predictability, as they will know exactly how much their monthly payments will be.
  • Variable-rate loans: Variable-rate loans have interest rates that can fluctuate over time. In rising rate environments this can be risky, as the rate you are required to pay can balloon quickly. In a decreasing interest rate environment, variable rate loans can be beneficial as the monthly payment also decreases.
  • Revenue based financing: Revenue-based financing (RBF) is a type of business funding in which a company secures capital by selling rights to their future projected revenue streams at a discount without dilution or the risks/requirements associated with debt. Learn more about RBF here.

Our thoughts on bullet loans

While bullet loans can be useful in certain circumstances (such as an acquisition, or as a bridge to a future round of equity financing), the more founder friendly alternative is revenue based financing. With revenue based financing, the total cost of capital is known upfront, there are fixed monthly payments and there are fewer requirements. Additionally, you can typically onboard and access capital from a revenue based financing provider in a couple of days, rather than a few weeks. Learn more about RBF here.

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