The Financial Covenants
Financial covenants are specific financial benchmarks that the borrower must satisfy during the term of the loan. The covenants generally change over the course of the loan, reflecting improvements in growth and financial condition that are expected to occur. The following are typical financial covenants in senior loans made in connection with private equity transactions:
- Leverage Ratio. Compares the borrower’s total debt from all sources to its EBITDA (earnings before interest, taxes, depreciation and amortization).
- Interest Coverage Ratio. Compares the borrower’s EBITDA to its cash interest payment obligations.
- Fixed Charge Coverage Ratio. Compares the borrower’s EBITDA minus capital expenditures to its fixed obligations for interest, principal on debt, cash dividends of preferred stock and income tax liabilities.
- Capital Expenditures. The amount the borrower can spend on capital expenditures.
