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Loan Covenants Examples

by Holly Magister, CPA, CFP

About Latest Posts

Holly Magister, CPA, CFP

Founder at Enterprise Transitions, LP and Exit Promise, LP
Holly A. Magister, CPA, CFP®, is the founder of Enterprise Transitions,
LP, an Emerging Business and Exit Planning �rm. She helps
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entrepreneurs assess, re-align, and accelerate their business with the
intent of ultimately executing its top-dollar sale.
Holly also founded ExitPromise.com and to date has answered more
than 2,000 questions asked by business owners about starting,
growing and selling a business.

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Have a Question? Add it to the bottom of this post!

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What Are Loan Covenants?
A covenant is simply a fancy term for the word ‘promise’. Banks include
covenants in their loan agreements to preserve their position as the

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lender and to improve the likelihood a loan will be paid back by the
business owner/borrower on time, in full, and in accordance with the
loan’s terms and conditions.

Loan Covenants spell out exactly

what the business owner agrees
to do with respect to the
business’ capital structure
during the term of the loan or
business line of credit.  These
promises made by business owners can vary and most loan documents
have some, but not necessarily all of the loan covenant examples
de�ned in this post.

Knowing what to expect when you apply for bank �nancing and
ultimately sign a lender’s loan document will help a business owner be
well-prepared before and during the term of the loan.

Types of Loan Covenants

Bank loan agreements may include three types of loan covenants.
 These include: A�rmative Loan Covenants, Negative Loan Covenants,
and Financial Loan Covenants.

Affirmative Loan Covenants

An a�rmative loan covenant is used to remind the borrower they
should be doing certain activities to maintain the �nancial health and
well-being of the business.  

Affirmative Loan Covenants Examples Include:

1.       Requirement to pay all business and employment-related taxes 2

2.       Requirement to maintain current �nancial records and to deliver
to the lender for review certain types of reports such as a Certi�ed
Public Accountant’s  Compiled, Reviewed or Audited �nancial statement  
each year.

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3.       Requirement to maintain adequate insurance policies for the

business and possibly include the lender as a separately named
‘additional insured’ party
4.       Requirement to maintain the business entity in good standing
with the state where it is formed

Negative Loan Covenants

A negative loan covenant is used to create boundaries for the company
and its owners.  Such boundaries are usually related to �nancial and
ownership matters.  

Lenders may include negative loan covenants which require the

business owner to seek the bank’s permission to take certain actions as
such actions may change the business’ capital structure.  Such
requirements to obtain the lender’s permission may seem as if the
business owner must ask “Mother, may I?…” and often are not evident to
the business owner until many months, or even years, after the loan has
been obtained.

Negative Loan Covenants Examples Include:

1.      Limiting the total amount of indebtedness for the business and/or

shareholders
2.     Restriction on or forbidding distributions and/or dividends paid to
shareholders
3.     Restriction on or forbidding management fees paid to related
parties
4.     Prevention of a merger or acquisition without the lender’s
permission
5.     Prevention of investment in capital equipment, real estate, or other
businesses without the lender’s permission
6.     Prevention of the sale of assets without the lender’s permission 2
7.     Maintenance of  a speci�c or targeted Debt Service Coverage Ratio

Financial Covenants in Loan Agreements

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Financial loan covenants are used to measure how closely the business
performs against the �nancial projections provided by the business
owner, CFO, or management.  Certain �nancial loan covenants may be
used to restrict the amount of credit the business can access from its
line of credit.

Financial Covenants Examples Include:

1.       Current Ratio (Current Assets divided by Current Liabilities

2.        Borrowing Base Calculation where a de�ned maximum
percentage is applied against the business’ eligible Accounts Receivable
to determine how high a Line of Credit may be drawn.

Breach of Loan Covenants

In the event the business owner violates one or more of the loan
covenants, the lender may dole out a number of consequences as it sees
�t.  Depending on the o�ense, your lender may simply voluntarily create
a waiver to accommodate the issue.  For example, if you forget to submit
your �nancial statements on time, they may simply extend the deadline.

However, in the event of a more serious violation (like taking out

another loan without your lender’s permission), your lender may have
the right to suspend its loan, demand early repayment, seize the assets
you pledged as collateral, halt any additional lending to you, or initiate
legal action.

And in most cases, lenders will charge additional fees to cover their
additional costs when a loan covenant has been broken by the
borrower.   These fees can be very costly.  These breach of contract fees
are de�ned in the loan or line of credit agreement in the �ne print. 2
Business owners should note that even an unintentional violation of a
loan covenant may become a serious matter.  Some banks automatically
turn their business accounts in violation of a bank covenant over to the

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Workout or Special Assets Group  for resolution.  Should this happen, a

business owner may be forced to �nd an alternative source of business
capital to grow their business.

Are Bank Loan Covenants Negotiable?

Absolutely yes! Loan covenants are negotiable between the bank and
the business owner when the bank or lender o�ers a borrower a loan
and de�nes its proposed terms in the form of a Letter of Interest.  

Although a lender’s Letter of Interest or credit facility proposal is not

binding on the part of the lender, it does serve as a good place for a
business owner to begin to understand how the lender intends to
impose loan covenants on the business owner.  It’s always best to
understand loan covenants before agreeing to accept a lender’s
business loan.

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Holly Magister is the founder of ExitPromise and has answered more

than 2,000 questions asked by business owners.

ExitPromise was created to help business owners start, grow and

ultimately sell a valuable business.

Other professional advisors have joined Holly to to help business

owners �nd the answers they seek and succeed.

Learn more about ExitPromise...

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