Debt Covenant
What It Means
A Debt Covenant is a contractual requirement that directs a borrower to perform, or refrain from performing, specific activities. Debt Covenants can be Positive, detailing actions a borrower must perform, or Negative, detailing actions a borrower cannot perform.
Examples of Positive Covenant Requirements:
Audited financial statements
Insurance coverage
Record keeping
Maintenance of assets
Financial ratios
Examples of Negative Covenant Requirements:
Pay dividends to shareholders
Borrow more debt
Sell certain assets
Issue new stock
Invest in new capital equipment
Why It’s Important
Debt Covenants are intended to protect lenders and align interest between a lender and a borrower, but they can have serious consequences. Depending on the specific terms in the debt agreement, when a Debt Covenant is violated the lender may have the right to demand repayment of the loan, convert the debt to equity, or even force the company into bankruptcy. It’s important to consider the terms and potential consequences carefully before accepting any debt offering.