Loan covenant

Buyers focus on the interest rate and the term, and then discover that the covenants are what actually constrain the business afterwards. A covenant package can limit how much additional debt can be taken on, how much the owner may draw, whether equipment can be sold, and whether a second location can be opened.

The two families

• Financial covenants — ratios that must be maintained and tested periodically, such as debt service coverage or a debt-to-equity limit
• Affirmative and negative covenants — things the borrower must do (deliver statements, keep insurance current) and must not do without consent (sell assets, take on new debt, change ownership)

What to negotiate before signing

Covenants are more negotiable at the term-sheet stage than most buyers assume. Testing frequency, the size of any cushion, and a cure period that allows a breach to be fixed before it becomes a default are all worth raising early, when the lender still wants the deal.