A loan covenant is a promise the lender can act on.
In short
The financial promises a UK lower-mid-market facility runs on. Maintenance covenants (leverage, meaning net debt to EBITDA, interest cover, and debt-service cover) are tested every quarter on trailing twelve-month numbers; incurrence covenants bite only when you take a specified action. Bank senior leverage is commonly 2.5 to 3.5 times EBITDA and unitranche runs nearer 4 to 4.5 times. Headroom, customarily 25 to 30%, is the gap between your forecast and the covenant, sized by running the downside case, and too little of it is the real risk. Definitions, add-backs, headroom and the equity cure are what to negotiate at term-sheet stage.
Written by Gregory Elgunov, Managing Director · Last reviewed 25 September 2026
Put the numbers to work: The debt-capacity calculator tests a loan against your own cash flow, rate, term and coverage, and shows the room left when rates rise.
A covenant is a contractual promise inside your facility agreement. Break one and the lender gains a defined right to respond, up to calling the loan, though it rarely comes to that. The financial covenants are the ratios your business must pass at every test date: leverage, interest cover and debt-service cover. Around them sit the undertakings, the promises to deliver accounts on time, keep the insurance in place, and take on no further debt and grant no further security without consent. This guide is about the financial covenants, because they are the ones a borrower can shape and the ones that bite. Section 05 has a calculator for the headroom on your own numbers.
Written for the borrower’s side of the table. This is general guidance, not advice on your specific facility. It comes before our guides to negotiating the term sheet and, if trading dips, handling a covenant breach, and deepens the shorter answers in our working guide.
Covenants are the lender’s early warning and its seat at the table.
A lender advancing against cash flow is repaid out of earnings it cannot see and does not control. Covenants turn that exposure into measurable promises tested on a schedule, so deterioration shows in the numbers a quarter or two before it shows in a missed payment, while there is still time to talk. Because a breach is an event of default, the ratios also give the lender a defined right to act before value leaks out of a weakening business: to reprice, to tighten terms, to ask for more information and, in the last resort, to enforce its security.
Leverage, interest cover and cash cover, tested every quarter.
A £3m to £15m facility typically carries two to four maintenance covenants, tested quarterly on a trailing twelve-month basis. Each tests something different, and the levels vary with the structure and the lender; your own documents set the numbers that bind. The table sets out what each measures, where it usually sits, what trips it and how to protect against it.
The financial covenants, what trips each, and how to protect against it.
| Covenant and what it tests | Where it usually sits | What trips it | How to protect against it |
|---|---|---|---|
| LeverageNet debt against trailing twelve-month EBITDA | Bank senior debt 2.5–3.5× EBITDA, unitranche 4–4.5× (the top of that with junior debt), a conservative senior deal 1.5–3×, with the covenant set above | A fall in EBITDA against a debt balance that barely moves, which is why it usually trips first | Headroom sized from the downside case, clear add-backs and an equity cure |
| Interest coverEBITDA against the interest on the debt | Set to the deal, below the cover the forecast produces | Lower earnings, or higher base rates on floating-rate debt | Hedging the floating rate, and headroom tested with rates stressed |
| Debt-service coverEarnings or cash against interest plus scheduled repayments | A little above 1.0×, common on amortising bank debt and asset-backed structures | Cash that covers the debt service, repayments included, by less than the set multiple | Headroom tested on a downside case that carries the repayments |
| Cashflow coverFree cash flow after tax and capital spending against debt service | Set to the deal, and stricter than debt-service cover | Heavy investment, which comes off before the test | A definition that leaves out capital spending funded by new equity |
| Capex limitCapital spending in the year against a ceiling | A cap in the agreement, usually with a modest carry-forward of unused allowance | A growth year that runs into the cap | The carry-forward, and a permitted overspend funded from new equity |
Interest cover is the covenant the rate environment moves directly. Bank facilities are priced at a low single-digit margin over SONIA, fund debt higher. SONIA sat at 3.73% on 22 September 2026 against a Bank Rate of 3.75%, held at the Bank of England’s September meeting. Bank of England, Bank Rate. As base rates rose, the interest line rose with them and interest cover compressed even where trading held. The capex limit, a ceiling on capital spending that protects the cash the lender counts on for debt service, is the covenant borrowers most often forget they have.
Why the leverage bands differ by lender is in our comparison of unitranche and bank senior debt, how leverage caps the size of a raise is in how much your business can borrow, and the full pricing stack is in our guide to the all-in cost of raising debt.
Maintenance covenants test you every quarter; incurrence covenants test only when you act.
A maintenance covenant is tested at every measurement date whether or not you have done anything, so a passive drift offside, a soft year or a lost contract, is itself the breach. An incurrence covenant is tested only when you take a specified action, such as raising more debt, paying a dividend or making an acquisition. You must show the ratio would still sit within an agreed level afterwards, and a ratio that drifts while you do nothing is no breach. The distinction decides how much room you have to trade through a bad patch without a conversation with the lender.
At £3m to £15m, expect maintenance covenants. Fully incurrence-based, covenant-lite packages belong to the large-cap market and some larger unitranche deals, reserved for the strongest credits. A lower-mid-market borrower meets incurrence logic inside the undertakings instead, as a permitted-acquisitions or permitted-debt basket available only while pro-forma leverage stays under a set level. That level decides what the business can do between tests without asking the lender, and it is set at term-sheet stage alongside the maintenance levels.
Headroom is the gap between your forecast and the covenant, and too little is the real risk.
Covenant headroom is the cushion between the level your base-case plan produces and the level the covenant is set at, measured as how far EBITDA can fall before the test fails. Customarily it is 25 to 30%, sized on the downside case rather than the plan. Take the forecast, stress it with what realistically goes wrong (a revenue miss, a margin squeeze, a delayed contract, a slow debtor) and set the covenant so a credible bad quarter still passes.
The calculator starts from the company in our guide to how much equity a management buyout needs, whose £6m of senior debt is 3.0 times its £2m of EBITDA (its vendor loan notes, subordinated paper a senior lender treats much like equity, sit outside net debt, a carve-out to agree in the term sheet). The covenant of 4.0 times is derived, as the level that leaves 25% headroom at 3.0 times (3.0 divided by 0.75). Put in your own figures and the fall your downside case produces.
How far EBITDA can fall before the leverage covenant breaks.
The guide’s example · edit any figure
Borrowing less cash, as your agreement defines it. Enter 0 if cash exceeds borrowing.
The most net debt to EBITDA the agreement allows.
The fall your downside case produces.
EBITDA can fall by
25%
to £1,500,000, before leverage passes the 4.0× covenant
- Leverage today
- 3.0×
- Rise in net debt the covenant can absorb
- £2,000,000
- Leverage after a 30% fall in EBITDA
- 4.29× · in breach
- Equity cure needed, applied to net debt
- £400,000
After a 30% fall, leverage of 4.29× is above the 4.0× covenant. An equity cure of £400,000 applied to net debt would bring it back to 4.0×; paying debt down from the company’s own cash would not, because net debt already counts that cash. Where the agreement counts the cure as EBITDA, £100,000 would do it.
| Fall in EBITDA, % | Net debt to EBITDA, times |
|---|---|
| 0 | 3.0 |
| 5 | 3.2 |
| 10 | 3.3 |
| 15 | 3.5 |
| 20 | 3.8 |
| 25 | 4.0 |
| 30 | 4.3 |
| 35 | 4.6 |
| 40 | 5.0 |
| 45 | 5.5 |
| 50 | 6.0 |
- Within the 4.0× covenant
- In breach
Each column is net debt to EBITDA, in times, after a fall in trailing EBITDA of 0 to 50%, with net debt unchanged. In practice falling earnings drain cash, so net debt rises and the breach comes sooner.
An illustration of the arithmetic, not advice on a facility: covenants are tested on the definitions in your own agreement, and its drafting governs. Calculated in your browser.
Illustrative: £2m of EBITDA, £6m of net debt, a 4.0 times covenant and a 30% fall in EBITDA to test.
On the example, EBITDA can fall by a quarter, to £1.5m, before leverage reaches the covenant. A 30% fall takes leverage to 4.29 times, a breach that an equity cure of £400,000 applied to net debt would put right, or £100,000 where the agreement counts the cure as EBITDA. Each further 5% step in the chart sits deeper in breach. Whether 25% is enough depends on your own downside case, and if that takes EBITDA lower than the headroom allows, the covenant is set too tight. Most leverage covenants step down over the life of the facility, so test the headroom at the tightest level in the schedule as well as the opening one.
A covenant set on top of the plan turns normal trading variance into an event of default, a waiver fee and a business-support conversation, and what follows is set out in our guide to a covenant breach.
In fund and unitranche structures the covenant may only spring when the revolver is drawn.
A covenant-loose package carries fewer maintenance covenants than a fully covenanted bank deal, often a single leverage covenant in place of three or four; a covenant-lite package, as No. 04 sets out, carries none. A springing covenant is tested only when the revolving facility is drawn past a set threshold, such as 40% of the revolver’s size, so with the revolver undrawn or lightly drawn there is no maintenance test to breach in an ordinary quarter. These structures belong to unitranche and other private-credit deals, as our comparison of unitranche and bank senior debt sets out.
Fewer tests leave the lender’s protection in the event-of-default and information provisions, a fund lender watches the monthly numbers closely regardless, and without a quarterly test a softening credit is flagged later, on the lender’s reading of the monthly pack, when the conversation starts from a weaker position. Bank senior debt at £3m to £15m is almost always fully covenanted, so the question arises only with fund debt.
Quarterly, on trailing twelve-month numbers, certified by you.
Financial covenants are tested as at each quarter-end on a trailing twelve-month basis, so that one strong or weak quarter is smoothed across the year. The compliance certificate follows within a delivery window, commonly thirty to sixty days. It is signed by a director, typically the finance director, sets out each covenant, its required level, the actual figure and the calculation, and confirms compliance or reports a breach.
The covenant is tested on the test date, whenever the certificate is filed, so model it forward from the quarter’s management numbers and use the weeks before the certificate is due to decide how to report and whether to speak to the lender first. The inputs are defined terms. EBITDA, net debt, the treatment of leases and shareholder loans and the permitted add-backs are all set by the agreement, and they can move a ratio materially from what the statutory accounts suggest. Our guide to a covenant breach runs the timeline from the test date to the fix.
The definitions, the add-backs, the headroom and the equity cure.
Covenants are set at term-sheet stage, and most of the package is negotiable. The lender proposes levels calibrated to protect itself; the borrower’s job is to trade the terms that cost the lender little and buy operating room. Four do most of the work.
Definitions and add-backs
How EBITDA and net debt are defined decides what the ratio measures, so a clear add-back list (exceptional items, one-off costs, defined run-rate benefits) can matter more than the level itself.
Headroom
Argue the levels off your realistic downside case with the customary 25 to 30% cushion. A covenant a little looser than the lender first offers is the cheapest insurance in the deal.
The equity cure
The right for shareholders to inject equity, or subordinated debt, to fix a ratio for a test, capped over the life of the loan (commonly three or four uses in total). It is now near-universal in leveraged facilities; on a bank facility for an owner-managed borrower it often has to be asked for. Ask for the cure to count as EBITDA: on the example in No. 05 that needs £100,000 where a cure against net debt needs £400,000.
The number and mix of covenants
A few well-defined covenants serve a borrower better than a long list of tight ones, and whether a lighter or springing structure is available depends on the lender and the credit. Trading these against fees and margin is covered in our guide to negotiating a debt term sheet.
We will set the covenants against your own downside case.
If you are agreeing a facility, or living with covenants that feel tight, a first conversation is confidential and costs nothing. We model the covenants forward on your own numbers, size the headroom off your downside case, and negotiate the definitions, add-backs and equity cure that keep ordinary trading variance from becoming a default. See how a mandate runs in how we work, or the full range of what we advise on in our services.
The terms in this guide
Each is defined in full in the library, with the levels and conventions that apply at £3-15m.
- Covenant headroom
Headroom is the gap between where your covenant is set and where you are trading, and it is the difference between a difficult quarter and a default.
- Debt service cover ratio (DSCR)
DSCR measures the cash available to service debt against everything the debt costs in the period, interest plus scheduled repayment. It is the tightest of the common covenants because it is the only one that counts amortisation.
- Equity cure
An equity cure lets shareholders inject money to fix a covenant breach after it has happened. It is a limited resource, capped in number and frequency, and how the cash is applied decides how much good it does.
- Information undertakings
Information undertakings are the reporting obligations in a facility agreement. They are the least negotiated covenants and the ones you live with every month, and late delivery says something about a business that its numbers may not.
- Interest cover
Interest cover measures earnings against the interest bill alone. It is the covenant most exposed to the cost of money rather than to trading, which is why a rate rise can move it when nothing about the business has changed.
- Leverage covenant
A leverage covenant caps your debt as a multiple of EBITDA, tested every quarter. It is rarely one number and rarely one measure: most facilities test several, on a schedule that tightens each year.
- Maintenance vs incurrence covenants
A maintenance covenant tests every quarter whether you like it or not. An incurrence covenant tests only when you try to do something. The difference decides whether a bad quarter is a default or merely a bad quarter.
- Springing covenant
A springing covenant is tested only once the revolving facility is drawn past a threshold. Below the line there is no quarterly test to fail, which is a smaller reprieve than it sounds.