Debt covenants 12 / 15

Debt covenants

Debt finance often comes with certain debt covenants from the lender.

Debt covenants are agreements between a lender and the borrower to not breach certain limits of financial ratios and to abide by other restrictions, for example:

  • Restrictions on dividend payments:
    This is to safeguard the company's future cash flows and ability to meets its debts.

  • Financial ratio limits:
    Certain financial ratios cannot fall below specified levels, eg interest cover, net debt/EBIDTA, debt/debt and equity.

  • Restrictions of additional debt:
    Lenders may restrict the type and amount of additional debt a company can take on or the nature of charges over assets that the company can issue.

Breaches of debt covenants usually entitle the lender to demand full repayment of the loan. However in practice this is unlikely; rather, the debt is re-negotiated.