Pricing
Original issue discount (OID)
Original issue discount means the lender advances less than the face amount of the loan. You receive 98 or 99 pence in the pound and repay the whole pound, so the discount is interest collected at the front.
Also called OID · upfront discount · funded at 98 · issue discount · below par funding
Funded at 98 on a £5m facility, £100k never arrives. You still repay £5m.
| Stage | Amount |
|---|---|
| Face amount | £5m |
| After OID at 98 | £4.9m |
| After 2% fee | £4.8m |
Illustrative on a £5m facility at 98, with a 2% arrangement fee. Derived arithmetic.
What funding below par means
A loan with original issue discount is documented at its face amount but funded at less than it. Funded at 98 means the lender advances 98 pence for every pound of principal you owe. On a £5m facility that is £4.9m into the account against £5m of debt on the balance sheet from day one.
In UK private credit the convention runs at 98 to 99. It is not a fee in the legal sense and it is not interest in the ordinary sense, which is precisely why it is easy to miss when comparing offers. It is a way of collecting yield at the front of the loan rather than over its life.
Why lenders use it
Two reasons, and they are worth understanding because they tell you where the flexibility is.
The first is yield certainty. A margin is earned only while the loan is outstanding, so a borrower who refinances after eighteen months deprives the lender of the return they underwrote. Discount collected at drawdown is earned whatever happens next. The second is presentational. A fund quoting SONIA plus 600 with 2 points of discount can appear to price inside one quoting SONIA plus 650 flat, while earning more if the loan is repaid early.
That second point is the reason OID exists as a negotiating variable at all. It moves cost out of the number borrowers compare and into one they often do not.
The shorter you hold it, the worse OID is. Repay in year one and 2 points cost you 2 points of yield.
| Held for | Added annual cost |
|---|---|
| 1 year | 2% |
| 2 years | 1% |
| 3 years | 0.67% |
| 5 years | 0.4% |
Illustrative yield impact of 2 points of OID spread over the holding period. Derived arithmetic.
OID against an arrangement fee
Both are taken at drawdown and both reduce what reaches the account, so borrowers frequently treat them as the same thing. Commercially they are close. Mechanically they differ in ways that matter.
An arrangement fee is a payment for putting the facility in place, is usually a stated percentage, commonly 1.5% to 3% at this size, and is charged on the commitment. OID is a discount to the principal advanced, expressed as a price rather than a percentage, and attaches to the amount drawn. On a facility with an undrawn tranche, that distinction has teeth: an arrangement fee on the full commitment is payable whether or not the delayed-draw tranche is used, while OID typically bites only on what is funded.
They also unwind differently. Where a facility is prepaid, an arrangement fee is spent. OID is already collected but its economic effect on your realised cost depends entirely on how long you held the money.
The gross-up nobody mentions
If a business needs £5m of cash to complete an acquisition, a £5m facility funded at 98 with a 2% arrangement fee does not do it. About £4.8m reaches the account, roughly 96% of the face amount.
The facility therefore has to be sized upward to deliver the cash the deal requires, which means more debt, more interest and a higher leverage ratio than the headline suggests. On a transaction where the funding requirement is fixed, work backwards from net proceeds rather than forwards from the facility size, and check that the grossed-up amount still passes the leverage covenant. This catches people at the worst possible moment, which is the week before completion.
OID is one of five upfront and back-end charges. Comparing offers on margin alone misses most of them.
| Component | When paid |
|---|---|
| Original issue discount | At drawdown |
| Arrangement fee | At drawdown |
| Legal and diligence | Front-loaded |
| Margin | Quarterly |
| Exit fee | On repayment |
Market convention at £3-15m. Individual facilities vary.
What it does to the real cost
The way to think about OID is as interest paid in advance and then spread over however long you hold the loan. Two points of discount on a facility repaid after one year adds roughly 2 percentage points to that year's cost. Held for five years, the same two points add about 0.4 of a point a year.
That asymmetry has a practical consequence. OID punishes exactly the outcome a borrower most often wants, which is to refinance early once the business has grown into cheaper debt. A facility with 2 points of discount, a non-call period and an exit fee can make an otherwise sensible year-two refinancing uneconomic, and the three provisions are usually found together.
When comparing a private credit offer at SONIA plus 550 to 800 basis points against a bank term loan nearer 6.75%, the discount is part of the gap and belongs in the comparison.
Accounting and tax treatment
In broad terms, the discount is not expensed at drawdown. Under an effective interest method it is treated as part of the cost of borrowing and amortised across the life of the instrument, so the profit and loss account carries a slightly higher finance charge each year rather than a lump in year one. On early repayment the unamortised balance is generally written off at that point.
The tax position broadly follows the accounting treatment for UK corporates under the loan relationship rules, subject to the corporate interest restriction and the usual anti-avoidance provisions. That is a general description rather than advice: the treatment depends on the instrument and the structure, and it is a question for the borrower's own advisers.
The practical point for a borrower is that the covenant definitions may or may not follow the accounts. Check whether the leverage test measures debt at face value or at amortised cost, because on a facility funded at 98 those are different numbers.
What is negotiable
More than borrowers expect, because OID is a price rather than a fixed convention. Three approaches work at £3-15m.
The first is simply to ask for it to be traded against margin. A lender indifferent between 2 points of discount and an extra 40 basis points on a five-year facility may not be indifferent on a three-year one, and finding out which they prefer tells you something about how long they expect to hold the loan. The second is to confine it to the funded amount rather than the commitment, which matters where a delayed-draw or accordion tranche exists. The third is to ask that any discount be treated as amortising for the purpose of prepayment protection, so an early repayment is not charged twice for the same period.
The strongest position is the ordinary one: a competitive process. A lender that knows it is being compared on all-in cost rather than headline margin has less reason to move cost into the discount in the first place.
Common questions
What does original issue discount mean?
The lender advances less than the face amount of the loan. Funded at 98 means you receive 98 pence for every pound of principal you owe, so a £5m facility puts £4.9m into the account while you remain liable to repay £5m. In UK private credit the convention runs at 98 to 99.
Is OID the same as an arrangement fee?
Commercially they are close, mechanically not. An arrangement fee is a stated percentage, commonly 1.5% to 3%, charged on the commitment. OID is a discount to the principal advanced, expressed as a price and usually biting only on what is drawn. On a facility with a delayed-draw tranche the difference matters, since a commitment fee is payable whether or not the tranche is used.
How much does funding at 98 cost?
It depends entirely on how long you hold the loan. Two points of discount on a facility repaid after one year adds roughly 2 percentage points to that year's cost. Over five years the same two points add about 0.4 of a point a year. OID is at its most expensive on facilities that are refinanced early.
Do I repay the discounted amount or the full amount?
The full face amount. That is the point of the mechanism: you receive 98 and repay 100. The 2 points are the lender's yield, collected at drawdown rather than over the life of the loan.
Do I need to increase my facility to cover the OID?
Yes, if you need a specific amount of cash. A £5m facility funded at 98 with a 2% arrangement fee delivers about £4.8m of usable proceeds. Where the funding requirement is fixed, such as an acquisition price, size the facility backwards from net proceeds and check the grossed-up amount still passes the leverage covenant.
Why do lenders use OID instead of just charging more margin?
Yield certainty and presentation. Margin is earned only while the loan is outstanding, so an early refinancing deprives the lender of the return they underwrote, while discount collected at drawdown is earned regardless. It also moves cost out of the headline margin, which is the number borrowers compare, so a quote of SONIA plus 600 with 2 points of OID can look cheaper than SONIA plus 650 flat.
Is OID negotiable?
More than borrowers expect, because it is a price rather than a convention. It can often be traded against margin, confined to the funded amount rather than the whole commitment, or treated as amortising for prepayment-protection purposes so an early repayment is not charged twice. A competitive process is the strongest lever, since a lender being compared on all-in cost has less reason to shift cost into the discount.
How is OID treated in my accounts?
Broadly, it is not expensed at drawdown. Under an effective interest method it forms part of the cost of borrowing and is amortised over the life of the instrument, with any unamortised balance generally written off on early repayment. The UK tax position broadly follows the accounting under the loan relationship rules, subject to the corporate interest restriction, but the treatment depends on the structure and is a question for your own advisers.
The full treatment sits in the guide: private credit fees explained.
This page explains a term as it is used in the UK lower-mid-market. It is general information, not advice on any particular facility. Terms vary between lenders and between deals, and the drafting in your own agreement governs.