Covenants in loan agreements — what you need to know

Financial covenants are expressed as ratios — net debt/EBITDA, interest cover, equity ratio or minimum liquidity. They are measured quarterly or semi-annually and reported via a compliance certificate.

Non-financial covenants are equally important. These include restrictions on dividends, acquisitions, additional debt, asset sales, change of control, and obligations to inform the bank of material events.

A well-calibrated covenant package has headroom — a safety margin between the company's forecast metrics and the covenant threshold — of at least 20–25 per cent. Anything less and normal seasonal variation can trigger a technical breach.

It is usually easier to negotiate headroom at signing than to seek a waiver later, which typically comes with a waiver fee and tighter terms.

A covenant breach rarely triggers immediate acceleration. It does, however, give the bank the right to demand a renegotiation, charge additional fees, tighten terms or — in the worst case — call the loan. Fast, transparent communication with the lender is critical.