A financial covenant is a binding condition written into a facility agreement that the borrower must satisfy on an ongoing basis — not just at the point of drawdown. Lenders use covenants to monitor the health of the business throughout the life of the loan and to give early warning if the borrower's financial position deteriorates materially.
Common types of financial covenant
- Interest cover: EBITDA (earnings before interest, tax, depreciation, and amortisation) must be at least a set multiple of the annual interest charge — for example, 2.5 times.
- Debt service cover ratio (DSCR): the business must generate enough cash to cover both interest and principal repayments by a set margin.
- Maximum gearing: total net debt must not exceed a specified multiple of equity or EBITDA.
- Minimum net worth: shareholders' equity or net assets must remain above a floor figure.
What happens if a covenant is breached?
A breach of covenant is technically an event of default, which can give the lender the right to demand immediate repayment of the full outstanding balance, increase the interest rate, or impose additional security requirements. In practice, many lenders will first engage with the borrower to understand the cause and may grant a formal waiver or amendment to the covenant if the breach is temporary and a credible plan is in place. Ignoring a breach and hoping the lender does not notice is always the wrong approach.
Covenants and Credicorp facilities
The conditions applicable to any Credicorp facility — including any financial tests — are set out in the specific facility agreement for that product. Short-term facilities over a defined fixed period have a different covenant profile from long-running revolving credit lines. The facility agreement is the authoritative document.
We lend only to UK limited companies and LLPs, and the loan is to the company with no director personal guarantee. As business finance outside the consumer-credit regime, it is not covered by the Financial Ombudsman Service or FSCS.
See also: What is gearing in business finance?, What is amortisation in business lending?.