Short answer
Covenants are promises a borrower makes in a loan agreement: things it must do, such as send monthly accounts, and things it must not do, such as take on more debt without consent. Financial covenants tie the loan to numbers, such as a minimum cash balance or revenue level. Breaching a covenant can be an event of default, which lets the lender demand repayment, so covenants should be set with headroom against your forecast.
Key facts
- Information covenants: monthly accounts, budgets, board packs
- Restrictive covenants: limits on new debt, asset sales, dividends
- Financial covenants: minimum cash, revenue or EBITDA tests
- A breach can be an event of default
What types of covenant are there?
| Type | What it does | Example |
|---|---|---|
| Information | Keeps the lender informed | Monthly management accounts within 30 days |
| Positive | Things you must do | Keep insurance in place; keep IP registered |
| Negative (restrictive) | Things you must not do without consent | No new borrowing; no sale of key assets |
| Financial | Numbers you must meet | Minimum cash of three months' burn; revenue at least 80% of plan |
Why do lenders use covenants?
Covenants are an early-warning system. A venture debt lender can't rely on profits, so it watches cash, revenue and burn. If the numbers drift, a covenant brings the company and the lender to the table early, while there are still options.
What happens if you breach a covenant?
A breach usually gives the lender the right, not the obligation, to demand early repayment. In practice most lenders start with a conversation: they may waive the breach, reset the covenant, or agree a plan, sometimes for a fee. The worst outcome comes from surprises, so tell your lender early if you expect to miss a test.
How to negotiate covenants
- Base every financial covenant on your own forecast, with headroom of 20–30%.
- Prefer cash or runway tests over EBITDA tests if you are loss-making.
- Ask for an equity cure: the right to fix a breach by raising new equity.
- Read the material adverse change clause carefully; ask for it to be narrow.
Related: Venture Debt →
Related questions
Does all venture debt have financial covenants?
No. Some facilities have only information and restrictive covenants. Others include financial tests. It depends on the lender and the company's risk.
Can a covenant breach lead to insolvency?
Only in extreme cases. Most breaches end in a waiver or reset, but a lender can demand repayment if the agreement allows it.