Covenants
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.
Also called incurrence covenant · maintenance covenant · cov-lite · incurrence test
One tests on a calendar, the other on your behaviour. That is the whole distinction.
| Type | Trigger |
|---|---|
| Maintenance | Every quarter |
| Springing | Quarterly, above a trigger |
| Incurrence | Only on an action |
Published: maintenance covenants are tested every quarter on trailing twelve-month numbers; incurrence covenants bite only when you take a specified action.
The distinction in one line
A maintenance covenant is tested every quarter on trailing twelve-month numbers, certified by you in the compliance certificate. It fires on the calendar, regardless of what the business does or does not do.
An incurrence covenant bites only when you take a specified action: raising more debt, paying a dividend, making an acquisition, disposing of a business above a threshold. If you never take the action, the covenant never tests.
That is the entire distinction, and everything else follows from it. One asks whether the business is healthy on a schedule. The other asks whether a particular thing you want to do is permitted.
What a maintenance covenant is for
It is an early-warning system with a fixed schedule. Leverage, interest cover and debt service cover measured quarterly give the lender a reading on the credit four times a year, whether the business is doing anything unusual or not.
The consequence for a borrower is that deterioration produces a default even where no decision was taken. A business that loses a customer and sees earnings fall breaches the covenant at the next test date, and a breach is an event of default even though nobody did anything wrong.
That sounds harsh and is the design working as intended. The purpose is to force a conversation early, while options still exist. A maintenance covenant is, in effect, a scheduled meeting the borrower cannot avoid, and early conversations are usually cheaper than late ones.
Incurrence tests gate the things that would change the lender's risk. They are permission gates, not health checks.
| Action | Gated? |
|---|---|
| Ordinary trading | No |
| Capex within limit | Rarely |
| Disposals above a threshold | 45–70 on the scale |
| Acquisitions | 65–88 on the scale |
| Dividends and new debt | Almost always |
Market convention at £3-15m. The specified actions vary by facility.
What an incurrence covenant is for
It is a permission gate rather than a health check. It asks: given what you propose to do, would the resulting position still be acceptable?
Typically the test is pro forma. Before paying a dividend you must show that leverage after the payment would still be below a defined level. Before raising incremental debt you must show that the enlarged debt still passes. Before an acquisition you must show the combined business, with acquired earnings annualised, meets the test.
The important structural feature is that it looks forward at a hypothetical rather than backward at a result, and it fires only at the borrower's initiative. A business that trades steadily and takes no gated action can hold an incurrence-only facility for its entire term without a covenant ever being tested.
Which actions are gated
Ordinary trading is not gated, and capital expenditure within an agreed limit usually is not either. Beyond that, incurrence tests cluster around the actions that change the lender's position without the business having deteriorated.
Raising additional debt is almost always gated, for the obvious reason that it dilutes the existing lender's recovery. Dividends and other distributions are almost always gated, because they move cash out of the business permanently. Acquisitions are usually gated, and disposals above a threshold generally are, since selling a business changes what the security covers.
The practical point at term-sheet stage is that these tests define your operating freedom for the life of the facility. A borrower planning bolt-ons or a dividend policy should read the incurrence baskets as carefully as the maintenance levels, because that is where the plan either fits or does not.
A maintenance covenant fires four times a year. An incurrence covenant might never fire at all.
| Covenant type | Tests over five years |
|---|---|
| Maintenance | 20 |
| Springing (half the quarters) | 10 |
| Incurrence (two actions) | 2 |
Illustrative on a business taking one dividend and one bolt-on over a five-year facility. Derived arithmetic.
Where each shows up
The distinction maps closely onto lender type at £3-15m.
A fully covenanted bank facility carries a suite of maintenance covenants, commonly three or four, alongside a set of incurrence tests. A fund or unitranche facility usually carries fewer maintenance covenants, often a single leverage test, sometimes springing only above a utilisation threshold of around 40% of the revolver, with more of the work done by incurrence provisions and information undertakings.
True cov-lite in the large-cap sense, where there are no maintenance covenants at all and only incurrence tests apply, is rare in the UK lower mid-market. What a borrower is usually offered when the word appears is a covenant-loose or springing package, which is a real difference from a full bank suite but is not the absence of quarterly testing.
The asymmetry a borrower should understand
Removing maintenance covenants removes a trigger, not a lender. Where a facility carries only incurrence tests, the lender's protection sits in the event-of-default provisions, the information undertakings and the security package rather than in a quarterly ratio.
That changes the shape of a bad period rather than eliminating it. Under a maintenance structure, deterioration surfaces at a defined date on an agreed ratio, and both sides know where they stand. Under an incurrence structure it surfaces when the lender reads the monthly pack and decides to raise it, on their timing and their interpretation.
For a borrower the second is more comfortable most of the time and less comfortable when it matters, because a conversation that starts late starts from a weaker position with fewer options still open.
What to negotiate in each
On maintenance covenants: the levels, the headroom against a downside case rather than the plan, the definitions of debt and EBITDA, the step-down schedule, and an equity cure. Headroom at the customary 25 to 30% matters more than the opening level, because it determines whether ordinary volatility produces a default.
On incurrence covenants the negotiation is entirely different in character. It is about baskets and thresholds: how much you may spend on acquisitions without a test, what dividend is permitted, what disposal proceeds may be reinvested rather than swept, and what incremental debt is pre-approved.
The mistake is spending all the negotiating capital on maintenance levels and accepting standard incurrence baskets. A business with an acquisition strategy will meet the incurrence provisions far more often than the leverage covenant, and a basket that is too small produces a consent request, a fee, and a delay every time it binds.
Common questions
What is the difference between a maintenance and an incurrence covenant?
A maintenance covenant is tested every quarter on trailing twelve-month numbers regardless of what you do. An incurrence covenant is tested only when you take a specified action, such as raising debt, paying a dividend or making an acquisition. One fires on the calendar; the other fires on your behaviour.
Which covenants will my facility have?
At £3-15m a fully covenanted bank facility usually carries three or four maintenance covenants plus a set of incurrence tests. A fund or unitranche facility typically carries fewer maintenance covenants, often a single leverage test, sometimes springing only above a revolver utilisation threshold, with more weight on incurrence provisions and information undertakings.
Can I breach an incurrence covenant without doing anything?
No, and that is the point. If you never take the gated action, the covenant never tests. A business that trades steadily and takes no dividend, acquisition or additional debt can hold an incurrence-only facility for its whole term without a covenant being tested once.
Which actions trigger an incurrence test?
Raising additional debt and paying dividends are almost always gated, because both change the lender's position directly. Acquisitions are usually gated, and disposals above a threshold generally are. Ordinary trading and capital expenditure within an agreed limit are usually not.
Is a facility with fewer maintenance covenants safer?
It removes a trigger rather than a lender. The protection moves into the event-of-default provisions, information undertakings and security. What changes is that deterioration surfaces when the lender reads the monthly pack and decides to raise it, rather than at a defined date on an agreed ratio, which is more comfortable most of the time and less comfortable when it matters.
Is true cov-lite available in the UK lower mid-market?
Rarely. True cov-lite, meaning no maintenance covenants at all with only incurrence tests applying, belongs to the large-cap market. What is usually being offered at £3-15m when the word appears is a covenant-loose or springing package: a real reduction from a full bank suite, but not the absence of quarterly testing.
What should I negotiate on incurrence covenants?
Baskets and thresholds rather than levels. How much you may spend on acquisitions without a test, what dividend is permitted, what disposal proceeds may be reinvested rather than swept, and what incremental debt is pre-approved. A business with an acquisition strategy will meet these far more often than the leverage covenant.
What is a pro forma incurrence test?
A test applied to the hypothetical position after the action rather than the actual position before it. Before paying a dividend you show that leverage after the payment would still pass; before an acquisition you show the combined business with acquired earnings annualised would still pass. It looks forward at what you propose rather than backward at what happened.
The full treatment sits in the guide: loan covenants explained.
This page explains a term as it is used in the UK lower-mid-market. It is general information, not advice on any particular facility. Terms vary between lenders and between deals, and the drafting in your own agreement governs.