Negotiating Financial Covenants, EBITDA Addbacks, and Equity Cures: A Borrower's Guide
Updated: 4 hours ago
By Trenton Roberts and Natalie Voels
Financial covenants are where a credit agreement stops being a loan and starts being a relationship with rules. The interest rate gets the attention at the term sheet stage, but the covenant package decides how much room the company has when a quarter goes badly, how much the owners have to write a check to fix a miss, and how quickly the lender can move from friendly reporting calls to a reservation of rights letter. We have written separately about how lender-side loan documentation is built. This piece sits on the other side of the table: what a borrower should ask for, and why.
Start with the definition, not the ratio
Most borrowers negotiate the number in the covenant. A maximum total leverage ratio of 4.50 to 1.00 sounds like a single term. It is really three terms: what counts as debt, what counts as EBITDA, and when the test is measured. A company can win half a turn on the ratio and give back a full turn in the definitions.
Debt first. Ask whether the leverage test uses total debt or net debt, and if net, how much unrestricted cash can be netted and whether there is a cap. Ask whether earnouts, deferred purchase price, seller notes, letters of credit, and capital leases count. An earnout that the company may never owe should not sit in the leverage calculation at full face value from the day the acquisition closes, and many credit agreements count it only once it is earned and payable. If the company plans acquisitions, this definition matters more than the headline ratio.
Then the measurement. Most maintenance covenants are tested quarterly on a trailing four quarter basis. That smooths out a bad month but also means a weak quarter stays in the calculation for a full year. Ask when the first test date falls. A first test date set too soon after closing gives the company no room to absorb transaction costs and integration noise.
EBITDA addbacks are the real negotiation
Consolidated EBITDA in a credit agreement is a defined term, not an accounting figure. It starts with net income and adds back interest, taxes, depreciation, and amortization, and then it keeps going. The addbacks are where borrowers and lenders spend most of their time, and for good reason: every dollar added back to EBITDA lowers leverage and raises coverage.
Addbacks we expect a borrower to request, and a lender to scrutinize, include:
Non-cash charges, such as equity compensation expense and non-cash impairment or write-downs, with an exception for charges that reflect a cash item in a later period.
Transaction costs for the financing itself and for permitted acquisitions, dispositions, and equity issuances, whether or not the transaction closes.
Restructuring, integration, severance, relocation, and similar one-time costs.
Projected cost savings and synergies from an acquisition or an operational initiative, often called run-rate or pro forma addbacks.
Management fees paid to a sponsor, to the extent the credit agreement permits them to be paid.
The first two categories rarely cause a fight. The fourth is where lenders push hardest. Projected synergies are a forecast, and a lender lending against forecasted earnings wants limits. Borrowers should expect three kinds of guardrails and should negotiate each one rather than accept the first draft.
The first guardrail is a cap. Lenders often cap run-rate synergies and sometimes restructuring charges at a percentage of EBITDA, calculated before or after the addback. The calculation method matters. A cap measured against EBITDA after the addbacks is larger than the same percentage measured before them.
The second is a realization window. Lenders want the savings to be reasonably expected to be realized within a set period after the action is taken, often stated in months. A longer window helps the borrower; a shorter one forces the company to show results.
The third is certification. Many agreements require an officer to certify that the savings are reasonably identifiable and factually supportable. That is a reasonable ask, and the borrower should make sure the officer who signs it actually has the backup. A compliance certificate is a representation to the lender, and an inaccurate one can become its own default.
There is one more practical point. Banking regulators have long watched the addback debate. In December 2025 the OCC and the FDIC withdrew the 2013 Interagency Guidance on Leveraged Lending and its related FAQs, and said banks should manage these exposures under general safety and soundness principles. That does not mean any lender will accept any addback. Credit committees still decide what they will lend against, and private credit funds were never bound by bank guidance in the first place. It does mean the conversation is more about the lender's own credit judgment than about a regulatory line.
Choosing the financial covenants themselves
Not every credit facility needs every covenant. The common menu is a maximum leverage ratio, a minimum fixed charge coverage or interest coverage ratio, and sometimes a minimum liquidity or minimum EBITDA test for earlier stage borrowers. Ask the lender which tests actually matter to its credit view, and offer to drop the rest.
A fixed charge coverage ratio deserves extra care. Its denominator usually includes scheduled principal payments, cash interest, cash taxes, and sometimes unfinanced capital expenditures and restricted payments. A company that plans a heavy capital spending year should see that build into the covenant model before signing. Ask whether capital expenditures financed with equity or with permitted debt are excluded.
Covenant levels should come from the company's own model with a meaningful cushion. Borrowers sometimes accept a level set close to the projection because the projection is confident. The cushion is the point. If the model shows leverage of 3.50 to 1.00 in the second year and the covenant is set at 3.75 to 1.00, a modest shortfall becomes a default. Ask for step-downs to follow the projected deleveraging, not to lead it.
Springing covenants are another tool. In a revolving facility, a lender may agree that the financial covenant is tested only when usage of the revolver exceeds a threshold. For a company that rarely draws, a springing test can mean the covenant almost never applies. Negotiate what counts as usage. Undrawn letters of credit and cash collateralized letters of credit are often excluded.
Equity cures: how to fix a miss with owner money
An equity cure lets the owners contribute cash after a covenant miss and have that cash treated as EBITDA, or applied to reduce debt, for purposes of recalculating the ratio. Done well, it turns a default into a funded fix. Done badly, it is a right the owners cannot use when they need it.
The cure terms that matter most:
How many cures, and how often. Many agreements limit cures to a set number over the life of the loan and prohibit cures in consecutive quarters. Borrowers should ask for the largest total and the most flexible spacing the lender will accept.
The cure amount. Lenders often cap the cure at the amount needed to bring the company into compliance. Borrowers sometimes ask to overcure for a cushion. Most lenders resist that, and the request is worth making only if the company expects to need room in the next test.
Timing. The contribution usually has to arrive within a set number of business days after the compliance certificate is due. Ask for a standstill during that window so the lender cannot accelerate while the owners are funding.
Treatment of the cash. Some agreements require cure proceeds to prepay the loan. Others allow the company to keep them. Lenders commonly disregard the cure amount for other purposes, such as building baskets or reducing pricing, and they often refuse to let the cash count twice, once as EBITDA and again as netted cash in the same test.
Form of the contribution. Cure money usually has to come in as common equity or another form of equity the lender accepts. Subordinated debt from the sponsor may not qualify unless the agreement says so.
For a founder-owned company without a fund behind it, the practical question is whether the owners could actually fund a cure on short notice. If not, the cure right is less valuable than a looser covenant level, and the negotiation should focus there.
What happens when a test is missed
A covenant default is an event of default, but most lenders do not want to accelerate a performing loan over a single quarter. The usual sequence is a waiver or amendment, often with a fee, tighter reporting, a pricing increase, or new collateral. The documents shape the borrower's leverage in that conversation.
Ask how amendments and waivers are approved. In a syndicated or clubbed facility, required lender approval is often a majority by commitments. Know who holds the votes. Ask whether the default interest rate applies automatically or only on the lender's election, and whether a covenant default alone triggers it. Ask whether a covenant default under the revolver also defaults the term loan immediately or only after the revolver lenders accelerate. These cross-default details decide how many parties are in the room.
Reporting covenants and the compliance certificate
Financial covenants are only as good as the information behind them. The reporting package usually includes monthly or quarterly financials, annual audited statements, a compliance certificate, and a budget. Before signing, the company's finance team should confirm that it can deliver each item on time. An audit deadline the company has never met before becomes a default risk on day one.
Ask for a materiality qualifier on notice obligations, a reasonable grace period on late deliveries, and a mechanism to correct a certificate that turns out to be wrong. If an error is discovered later and the corrected numbers show a miss, borrowers want the right to cure that historical miss as if it had been tested correctly.
Where the borrower has leverage
Every credit negotiation has a moment when the borrower has the most room: before the term sheet is signed, when more than one lender wants the deal. That is the time to set the EBITDA definition, the cure right, and the covenant levels. After the term sheet, lenders treat those points as agreed. After closing, every change costs a fee.
Borrowers working on an acquisition should also coordinate the credit agreement with the purchase agreement. A working capital true-up or earnout can move cash in or out after closing. The credit agreement needs to permit those payments and treat them sensibly in the covenant math.
How we can help
We review and negotiate credit agreements, guarantees, and security documents for borrowers, and we work alongside the company's finance team and outside accountants so the covenant model and the documents describe the same business.
If you have a term sheet or a credit agreement draft on your desk, email info@robertsandwillie.com or call (469) 910-4017. Sending a message does not create an attorney-client relationship.
This article is for general information and is not legal advice. Attorney Advertising. Roberts & Willie, PLLC, Dallas, Texas; Trenton Roberts, responsible attorney.
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