How to think covenants?
I moved over to PE from MbB. Debt is new to me. If my partner / MD asks me what type of covenants would you recommend for this kind of business, how can I form an opinion? What about excess sweep? What are the things that I should be fighting for with respect to lender negotiations? Just arguing for higher threshold limits and more attractive pricing?
We live in a cov-lite world now so maintenance covenants don't really exist unless the company is an absolute dog. Incurrence covs can just be as aggressive as allowed by the market - lawyers drafting the docs and cap markets placing the debt should know.
To play devils advocate, I’ll respectfully disagree that “unless a company is dog shit it won’t have any covenants”. Albeit, the debt fund I’m at (senior, unitranche, mezz, distressed debt, equity) is lower middle market - $5-$50 million of EBITDA. On our side, we’ll get at least a TNL (total net leverage) covenant - usually with ~30-35% cushions (however covenant wide is not uncommon) and occasionally push for a FCCR when we see that there’s a decent amount of recurring capex - obviously would like to be able to turn capex off if things are going south and FCCR is under ~1.1x as we’d want our debt to be repaid and to limit other fixed payments / investments
Note that from a upper mid market perspective I 100% agree that covenants are seldom available, but from a LMM perspective it’s still apparent.
Why do we live in a covenant lite world and what does it mean? Is it regularly tested?
When a company wants to take out a loan there is a credit agreement between the lender and the borrower that outlines financial benchmarks that the borrower must maintain as well as financial actions the borrower cannot undertake. These stipulations are called covenants. Generally, covenants exist to protect lenders to ensure that they are paid back. Cov lite is a term used to describe credit agreements that lack these protections. Nowadays, we are seeing an overwhelming amount of new debt being issued as cov lite because investor demand for this type of debt has increased so much that these deals are being pushed out with increasingly borrower friendly terms. As another poster mentioned, unless the company is absolutely dogshit, there won’t be any covenants that outline financial performance benchmarks that must be met.
It honestly shocks me how lenders are willing to do some of these cov-lite deals. Just too much competing capital and we’re in a good market I guess. Just did a deal with no total leverage covenant, only a 7.5x net senior secured springing covenant tested at the end of each Q.
Market will bear it for the most part.
When you have a big deal and it’s syndicated, covlite is sort of necessary to allow the company to just do its thing, do acquisitions, and the syndicate should be covered by leverage limitations on incremental debt, because it’ll be too expensive and draining to get an amendment. Leverage isn’t really an issue until the business completely sucks at which point liquidity will be a problem and they’ll pull the revolver anyway and trip into it.
In a direct deal, you’re way more likely to see a maintenance covenant (probably all the way up to $100-150m of Ebitda) because you have much closer relationship btwn sponsor and lender and so working out an amendment is a much easier thing, fewer traps to run.
Why would a $100-$150mm of (real) ebitda business do a direct deal with anyone at this stage of the cycle when they can hit the syndicate, let the market drive down price, and jam through whatever swiss cheese doc they want
You don't need a covenant if you never have to trip one. Syndicated loans are basically floating secured bonds at this point. Bonds generally don't have maint covs (but much better call pro).
Why floating ? Why not fixed?
Vitae commodi qui ratione ea voluptatibus inventore earum aliquam. Distinctio itaque magni qui quam quos possimus officiis labore. Est autem molestiae facere sed. Ipsum consequuntur omnis repellat rerum deleniti voluptatum nihil.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...