Covenant
Private Equity glossary · Advanced LBO Modeling Mechanics & Deal Structuring
Definition
Contractual provision in a credit agreement constraining the borrower or requiring specified financial metrics. Two main types: (i) maintenance covenants — tested quarterly (e.g., Total Leverage Ratio ≤ 6.0x, Interest Coverage ≥ 2.0x); breach triggers default, requiring waiver/amendment or equity cure; (ii) incurrence covenants — tested only when the borrower takes a specific action (issuing new debt, paying a restricted dividend, etc.). Investment-grade and 'cov-lite' Term Loan B facilities typically use incurrence-only; middle-market and direct-lender deals retain maintenance covenants.
Covenant in plain English
When a company borrows money, the loan contract includes promises called covenants — rules the borrower must live by so the lender feels safe getting paid back. There are two flavors. A maintenance covenant is a health check-up done every quarter, like a rule that debt can't exceed 6 times yearly profit (Total Leverage ≤ 6.0x); if you fail, you're in "default" and must renegotiate or have owners inject fresh cash (an "equity cure"). An incurrence covenant is looser — it only kicks in when you try to do something risky, like take on more debt or pay owners a special dividend; big "cov-lite" loans use these, while smaller loans keep the stricter quarterly checks.
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