Appropriate model for deferred costs as a line-of-credit

Question

I have a business situation where one party will agree to defer some costs until a future date, perhaps two years, but no fixed time. This principal will increase linearly over the course of 6 months (deferred costs are for hourly work).

After two years, the lender is repaid in a lump sum. Alternatively, the debtor would have become insolvent and the lender doesn't get paid back.

Because the principal is built over time, it seems to me to be rather like a line-of-credit. But instead of interest payments, there is proposed an equity stake in dollars at the debtor's current valuation.

How can we model a reasonable dollar value of waiving the interest on this line of credit? Including the fact that periodic payments will not be made.

What is the (range of) fixed interest rate that our U.S./global market currently supports?

Starting out, there's no collateral, and high risk to the lender (perhaps) but the principal is small. As the principal grows, the risk falls as certainty increases. The lender would be contractually obligated to work the full project, but is also directly involved and has major influence on the outcome (solvency).

Is there a standard formula for this situation?

Thanks!

Answer 1

There's no standard formula. You can compare the going rates on the market for unsecured LOCs and take that as the starting anchor. Unsecured lines of credit run in the US at about 8-18%.

Your risk should be reflected in the rate, and I see no reason why the rate would change throughout the loan.

As to the amount of principal changing? Just chose one of the standard compounding options - daily (most precise, but most tedious to calculate), monthly average balance, etc.