Mechanics
Prepayment protection
Prepayment protection is what a lender charges if you repay early. It protects their expected return, and it is the provision that decides whether you can refinance into cheaper debt when the business improves.
Also called call protection · non-call period · make-whole · prepayment fee · early repayment charge
The ladder steps down each year. Repay in year one and you pay three points; wait until year four and you pay nothing.
| Year of repayment | Charge |
|---|---|
| Year 1 | 3% |
| Year 2 | 2% |
| Year 3 | 1% |
| Year 4+ | 0% |
Convention from the all-in-cost guide. Individual facilities vary.
What it protects and why it exists
A lender underwrites a return over an expected holding period. Margin is earned only while the loan is outstanding, so a borrower who repays after eighteen months delivers a fraction of the return the credit committee approved. Prepayment protection restores some of that.
It is therefore not a penalty in the ordinary sense, and framing it as one leads borrowers to negotiate the wrong thing. It is a price for optionality: the right to leave early has value, and the lender is charging for it. The useful question is not whether it is fair but how much that option is worth to you, which depends entirely on how likely you are to want out before maturity.
The ladder and the non-call period
Two constructions do most of the work, and they are often combined.
A step-down ladder charges a declining percentage of the outstanding balance by year. The common shape is 3% in year one, 2% in year two, 1% in year three, then par. A non-call period is blunter: it prohibits voluntary repayment entirely for a defined period, typically the first year or two, rather than pricing it.
A facility with a two-year non-call followed by a 2% and 1% step-down is materially more restrictive than the ladder alone, because during the non-call window there is no price at which you can leave. Where a business might realistically sell or refinance inside that window, converting the non-call into a priced year is usually worth more than shaving the percentages.
On £5m the ladder is £150k in year one. Add unamortised discount and the real cost of an early exit is higher again.
| Year of repayment | Total cost |
|---|---|
| Year 1 | £230k |
| Year 2 | £160k |
| Year 3 | £90k |
| Year 4 | £20k |
Illustrative on a five-year £5m facility: the 3/2/1/par ladder, plus 2 points of OID (£100k) amortised straight-line and written off on early repayment. Derived arithmetic.
Make-whole, and why it is rarer here
A make-whole requires the borrower to pay the present value of the interest the lender would have earned to maturity, or to a defined call date. It is a full compensation mechanic rather than a stepped approximation, and it is standard in bond markets and in some US private placements.
At £3-15m in the UK it is uncommon on ordinary senior and unitranche facilities, where a percentage ladder is the norm. Where it does appear, usually on longer-dated or fixed-rate instruments, the cost of an early exit can be several multiples of a 3% first-year charge, because it is calculated on the whole remaining interest stream rather than a point of the balance.
If a make-whole appears in a term sheet, model the exit cost at the earliest date you might realistically want to refinance before agreeing to it. The number is frequently larger than anyone expects from reading the clause.
Which repayments trigger it
The trigger is usually voluntariness rather than the fact of repayment. Scheduled amortisation is free by definition. A mandatory prepayment out of a cash sweep is normally exempt too, because the borrower is not choosing to repay, though that exemption should be confirmed in the drafting rather than assumed.
A voluntary partial prepayment from surplus cash sits in the middle. Many facilities allow a free allowance, often a percentage of the original commitment each year, with the charge biting only above it. A full refinancing with a new lender almost always attracts the charge, which is the case the provision is designed for.
Repayment on a sale or change of control usually triggers it as well, and that is worth attention where an exit is in contemplation. A carve-out releasing the charge on a genuine third-party sale is a reasonable request and is sometimes granted, because the lender is not losing to a competitor.
Not every repayment triggers the charge. What you are repaying with usually matters more than that you are repaying.
| Repayment type | Charged? |
|---|---|
| Scheduled amortisation | Never |
| Mandatory cash sweep | Normally exempt |
| Voluntary partial | Sometimes |
| Sale or change of control | Unless carved out |
| Refinancing | Almost always |
Market convention. Carve-outs are negotiated deal by deal.
How it compounds with OID and PIK
The three provisions are usually found together on a fund facility, and they interact in a way that catches borrowers out.
On a £5m facility funded at 98, an early repayment in year one attracts £150,000 of call protection while £80,000 of the £100,000 discount remains unamortised, so the real cost of leaving is closer to £230,000 than to the 3% headline. Where the structure carries a PIK element, accrued interest has also increased the outstanding balance the percentage is applied to, so the same 3% is charged on a larger number than was originally advanced.
The practical test before signing is to model a refinancing at the end of year two, which is when most borrowers who improve want to move. If the combined cost of call protection, unamortised discount and crystallised PIK exceeds the saving from cheaper debt, the facility is effectively locked for longer than its stated non-call period.
Bank against fund
The convention differs sharply by lender type, and it is one of the underrated differences between a bank package and a fund package.
Bank term facilities at this size are frequently repayable at par on notice, with no call protection at all or a short and modest step-down. Debt funds almost always price the option, because their return model depends on it and their capital has a defined life.
That difference belongs in an offer comparison. A fund quoting a competitive margin with a three-year ladder is offering a different product from a bank quoting slightly wider with free prepayment, and the gap is worth real money to a business expecting to grow into cheaper debt within the term.
What moves in negotiation
Five things, in rough order of value to a borrower who expects to improve.
Converting a non-call period into a priced year, so an early exit is expensive rather than impossible. Shortening the ladder from three years to two. A carve-out for repayment on a genuine third-party sale. A free prepayment allowance each year, so surplus cash can reduce the balance without a charge. And portability, allowing the facility to survive a change of control on defined terms, which removes the trigger entirely in the situation where the charge would be largest.
The percentages themselves move least, because they are the part the lender's return model is built on. The structural terms around them move more readily and are usually worth more.
Common questions
What does it cost to repay a business loan early?
On a common ladder, 3% of the outstanding balance in year one, 2% in year two, 1% in year three and nothing from year four. On a £5m facility that is £150,000 in year one. If the facility was funded at a discount, the unamortised portion is usually written off on repayment too, taking the real cost closer to £230,000.
What is a non-call period?
A period, typically the first year or two, during which voluntary repayment is prohibited outright rather than priced. It is more restrictive than a ladder because there is no amount you can pay to leave. Converting a non-call year into a priced year is usually worth more than negotiating the percentages down.
Do I pay a prepayment fee on a mandatory cash sweep?
Normally not, because a mandatory prepayment is not a choice you are making. It is worth confirming in the drafting rather than assuming, and worth checking whether swept amounts count against any free prepayment allowance you were relying on.
What is a make-whole and how is it different?
A make-whole requires you to pay the present value of the interest the lender would have earned to maturity, rather than a stepped percentage of the balance. It is standard in bond markets and uncommon on UK lower-mid-market senior and unitranche facilities. Where it appears, the exit cost can be several times a 3% first-year charge, so model it at your earliest realistic refinancing date.
Do banks charge call protection?
Less often than funds. Bank term facilities at £3-15m are frequently repayable at par on notice, or carry only a short modest step-down. Debt funds almost always price the option because their return model and their capital's defined life depend on it. That difference belongs in any comparison of a bank offer against a fund offer.
Does prepayment protection apply if I sell the business?
Usually yes, unless carved out. A repayment on a sale or change of control normally triggers the charge. A carve-out releasing it on a genuine third-party sale is a reasonable request and sometimes granted, since the lender is not losing the loan to a competing lender. Portability, letting the facility survive the change of control, removes the trigger entirely.
Can I make partial repayments without a charge?
Often, within limits. Many facilities include a free prepayment allowance, commonly a percentage of the original commitment each year, with the charge applying only above it. Where no allowance exists it is a sensible thing to ask for, because it lets surplus cash reduce the balance without triggering the ladder.
How do I work out whether I am locked in?
A refinancing at the end of year two is when most improving borrowers want to move, and it is the case worth modelling. Add the call protection charge, any unamortised original issue discount written off, and any accrued PIK crystallising as cash. If that total exceeds the saving from cheaper debt, the facility is effectively locked for longer than its stated non-call period.
The full treatment sits in the guide: all in cost of debt.
Related terms
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.