Debt covenants can be a big stumbling block for many growing businesses. Unfortunately, this can often result in reverting to the familiar albeit, costly, equity route. But, once you understand the typical loan covenants and how to avoid them, you’ll be raising debt to reach your goals.
What Is A Debt Covenant?
Common debt covenants require a borrower to adhere to contractual rules in the form of specified actions or conditions in the loan agreement.
Typical debt covenants include:
- Cash covenants: A request for a percentage of the outstanding loan balance to be kept in the company bank account.
- EBITDA/forecast covenants: Here, a loan is agreed against a forecast. The borrower is expected to deliver in line with those estimates, with, usually a 10-20% variance.
What are bank covenants?
A traditional lender or a bank will typically ask you the following questions:
- What is your EBITDA ratio, and how well can it cover your debts?
- Is your cash flow sufficient to support operations and pay back a loan?
- Will liquidation of your assets pay back a loan?
It doesn’t cite a warm fuzzy feeling now, does it? And if you’re unable to answer them with confidence, they will likely issue negative loan covenants that’ll put a stranglehold on your growth.
What Happens If You Breach A Debt Covenant?
Tech companies invest heavily in Intellectual Property (IP), so when a lender becomes the senior creditor, in the event of a default, debt covenants pose a significant problem.
A debt covenant breach can result in punitive fees and most worryingly, a forced repayment of the entire sum.
What about Covenant-Lite Terms?
Covenant-lite terms to suit fast growing companies with innovative business models won’t come from the bank. Instead, look to private funds, they will understand your pre-profit, loss-making proposition and see potential
Private funds see value in:
- Fast growth rates
- Businesses backed by VC/PE money
- A sound business model, growth plan and, a recurring revenue stream
They ask questions unlike traditional lenders:
- What is the probability that this tech business has the ongoing ability to grow?
- How will it attract investors and transition into profit?
- Will the company’s total value be sufficient to pay off my loan should investor support prove insufficient?
To compensate for the risk, private debt funds can:
- Value and use IP as security
- Combine loans with warrants
- Ask for regular access to financials, external reporting, and compliance requirements
On the occasion lenders do include covenants in the debt terms, they will structure them to suit your business plan, revenue streams, and capital strategy.
As a result, they are comfortable in structuring covenant-lite deals that satisfy growth ambitions.
What Can You Use Covenant-Lite Leveraged Loans For?
Whatever your growth stage, covenant-lite leveraged loans, can help you on your way to success by:
- Extending cash runways
- Bridging a funding gap
- Reaching a big milestone
- Funding an acquisition or other growth expenses
- Avoiding a down-round
- Providing a financial cushion to protect you from inflection points
Debt funds understand when the right time to scale for success is and can help you to achieve your goals.
How can you avoid negative loan covenants?
To take on debt without signing up to restrictive debt covenants, you just need to know where to look.
At Fuse Capital, we have completed 100’s of deals for loss-making tech businesses across the world. Our large network of funds offers covenant-free and covenant-lite deal structures for businesses just like yours. Plus, you can feel encouraged knowing that we ask the right questions and can structure terms that’ll satisfy your growth ambitions.
Find out if you’re eligible for covenant-lite growth capital today.
