Also known as a “balloon payment” or “bullet repayment,” a bullet payment is a lump sum payment made for the entirety of the outstanding balance on a loan. They are most common at the end of the loan term.
Some bullet payments are large relative to the cash held by a company. Therefore, they require planning months in advance in order to have the cash available or to refinance the amount.
In the world of SaaS lending, bullet payments are common in three scenarios:
- Interest only loans
- Loans using amortization that include a bullet payment
- Loans using percentage of revenue as a repayment method
Interest only loans:
Many lending institutions will offer growth capital to be repaid as a bullet payment at the end of the term. Interest payments are made every month and the principal will be paid off in full at the end of the term (bullet payment).
This is known as an interest only loan—sometimes referred to as a straight loan.
On a $1,000,000, 5-year fixed term loan using amortization at 20% interest, the payment would be: $26,494
If you were to pay only interest, you’d have a $16,667 payment, giving your company nearly $10,000/mo in extra cash flow to use.
However, the interest only loan would costs you over $410,000 more in interest:
Loans using amortization that include a bullet payment:
Some lenders offer partially amortized loans in an effort to keep the monthly payment lower. These loans have a smaller bullet payment due at the end of the term.
You were offered a $1,000,000 loan at 20% interest. That loan would cost you $26,494/mo for 60 months using amortization. Instead, you take out a $1,000,000 loan ending with a $430,000 bullet payment. Your new monthly payment is $22,200/mo.
The bullet-payment loan is $250,000 less in payments over 5 years but will increase your total cost of finance by $172,000.
($22,200 * 60) + $430,000 = $1,762,000
($26,494 * 60) = $1,589,640
Loans using percentage of revenue as a repayment method:
The percentage of revenue method of repayment is an alternative to the fixed payment schedule. This method is popular amongst SaaS lenders because it gives growing companies access to more cash they can use to grow in the short-term.
When using this method, a lender cannot be certain a company’s revenue will be sufficient to repay the entirety of the loan by the end of the term. In some cases, a bullet payment may be required. In other words, a borrower may need to pay the remaining balance in a lump sum.
Our thoughts on bullet payments:
Firstly, the main advantage of a bullet loan is lower payments. However, these lower payments don’t always result in better long-term growth than a loan with more consistent payments.
When making smaller payments at the start of a loan, companies need to maximize growth to offset both the overall increased cost of finance and the opportunity cost at the end of the loan.
Towards the end of the loan, you have to start saving cash to make the bullet payment instead of reinvesting this money in growth – the loan has to be paid back at some stage.
We have seen in the past that a lot of companies are not prepared in time to make a large lump sum payment. If this happens to you, you may find yourself in a tricky spot of not having the cash on hand to make the payment and be forced to seek refinancing.
You take out a $1.5m loan and are doing $4m in ARR. If you repay 80% of it, you’ll still owe $300k. You can find the $300k. However, it would be much harder to repay $800k or the full $1.5m without some costly refinancing.
Refinancing can be quite difficult for a SaaS company to do depending on the market conditions at the time. Likely, the company worked with a SaaS lender because big banks didn’t offer what they needed, so they’ll have to return to the SaaS market.
SaaS lenders prefer their loans to be used for growth and their borrowers to be growing in revenue, which can be used to repay the loan. If marketing conditions aren’t right, lenders will be extra cautious. Therefore, affordable financing may not be available.