AFO · Glossary
Covenant
A contractual promise in a loan agreement that the borrower will (or won't) do something, breach of which triggers lender remedies.
What this term means in practice
A covenant is a contractual promise inside a loan agreement. Financial covenants set ratios the borrower must maintain (e.g., a minimum DSCR of 1.2x, a maximum total leverage of 3.5x EBITDA, a minimum tangible net worth). Affirmative covenants require the borrower to do things (deliver monthly financials, maintain insurance). Negative covenants prohibit specific actions (taking on additional debt, paying dividends, selling assets above a threshold).
Covenant breach triggers lender remedies — at minimum a default notice, possibly a hike in the rate, sometimes the right to demand immediate repayment. Even when the lender chooses not to call the loan, a covenant breach gives them leverage in the next renegotiation. The headroom matters: a DSCR set at 1.2x against a business currently running at 1.21x is a covenant that will likely breach inside 12 months on any soft quarter.
The CPA models covenant headroom under realistic and downside scenarios before the deal closes. The right covenant is one where the business can absorb a normal cyclical downturn without breaching; covenants that breach on routine variance create unnecessary lender conversations.
Where this matters in the catalog
Programs that turn on Covenant.
Conventional Senior Term Loan or Revolver
Cash-flow-underwritten facility from a chartered bank, credit union, or Schedule II lender.
ABL Revolver (Asset-Based Lending)
Revolving line tied to eligible receivables and inventory. Scales with the business.
Mezzanine Debt
Second-lien or subordinated debt when senior capacity is exhausted.
See also
Related glossary terms.
Where the definition meets your situation.
The CPA can walk through how this concept applies to your business in twenty minutes — what providers will ask, where the negotiation matters, what the trade-offs actually look like in your numbers.