The following is for informational purposes, and not meant to be legal advice.
What is the process a bank goes through in connection with making a loan? What are some of the types of loan agreement covenants, and how does one go about negotiating them?
Operating covenants may be negative or affirmative. Affirmative covenants include provisions that require a company to maintain its corporate existence, comply with laws, and maintain property and insurance. When negotiating these covenants, be sure to review items that have material effects on the company.
For instance, events of default should allow for a cure period. There should be qualifiers to the requirements such that the provisions make it practical to comply with. For example, requirements to submit reports to the bank should be part of the business practices, with a rational time allowed.
If third parties are involved in the compliance of covenants, a company should first check with the third party. For example, if a provision requires the work of accountants, the company should first check the costs and determine whether its auditors are able to comply.
Negative covenants impact a company's operating flexibility. These covenants relate to financial terms such as EBITDA, leverage ratios. The bank reviews a company's forecasts and projections.
Negotiate when the financial covenants are measured, whether monthly, quarterly, or yearly. Financial covenants measured monthly are usually more difficult to meet. Most companies' businesses are quarterly driven. Factor in the seasonality concerns.
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