2 min read
Types of covenant
Financial covenants require your business to maintain specified ratios at test dates — typically quarterly or semi-annually. Common metrics include minimum interest cover (EBITDA divided by net interest expense), maximum leverage (net debt divided by EBITDA), and minimum tangible net worth. Breach of a financial covenant is technically an event of default even if you are current on all payments.
Operational or affirmative covenants govern conduct: you undertake to maintain adequate insurance, comply with law, preserve key licences, and avoid material changes to the business. Negative covenants restrict actions — selling assets above a threshold, incurring further debt, or paying dividends without consent.
What happens when a covenant is breached
A breach gives the lender the contractual right to declare the loan immediately due and payable, appoint an administrator, or take enforcement action over secured assets. In practice, well-run lenders will typically engage with a borrower before escalating — particularly for a technical breach rather than a payment failure. However, this is a commercial decision, not an obligation.
If you anticipate a covenant breach, the correct course is to approach the lender before the test date, not after. Lenders are generally more willing to grant a waiver or covenant reset if they learn of the issue proactively rather than discovering it from submitted accounts.
Negotiating covenants at the outset
Covenants are negotiable at term sheet and facility agreement stage. Directors should model their projected financials against proposed covenant levels with headroom — a company projecting 2.5x interest cover should not accept a covenant set at 2.4x.
- Request 'equity cure' rights allowing shareholders to inject capital to remedy a financial covenant breach
- Negotiate the definition of EBITDA: addbacks for one-off items, capitalised development costs, and management charges all affect covenant headroom
- Agree the frequency and format of management information — monthly board packs differ from quarterly covenant certificates
Frequently asked questions
Can a covenant be changed after the facility is signed?
Yes, with lender consent. Amendments and waivers are agreed by way of a formal letter or deed of amendment, usually subject to a fee. Repeated amendments can signal underlying financial stress to the lender's credit team.
Are covenants the same across all lenders?
No. Covenant packages vary significantly between lenders, between secured and unsecured facilities, and by sector. Some alternative lenders provide covenant-lite or covenant-free facilities in exchange for higher pricing or more security.
Funding for UK limited companies
Credicorp lends to your company, not to you personally — short-term working capital with no personal guarantee. See what your business could access.