Negotiating Tips On Debt Covenants and Personal Guarantees

Non-compliance with debt agreement financial covenants can be costly, time-intensive and distracting to your business. Once you are out of compliance, lenders typically charge significant waiver fees, and the process to return to compliance often requires weeks of back-and-forth negotiations between your company’s chief financial officer/controller, the bank representative and the underwriter.

Therefore, when initially negotiating debt funding with your lender, it is important to understand the financial covenants your lender expects you to uphold and the variables that could prevent compliance. In addition, be sure to know the risks you assume when personally guaranteeing debt obligations.

Two common financial covenants typically included in a debt agreement are fixed-charge coverage ratio and funded debt to EBITDAR. Many variables should be considered when negotiating these covenants to ensure you can comply, including:
  1. Negotiate the exclusion of new debt proceeds received for the construction of a new store or remodel from covenants until the new location is open or the remodel is complete, as the total EBITDAR will not reflect the EBITDAR expected to be contributed from the new or remodeled store.
  2. Negotiate the definition of what income taxes may be excluded as there are many state taxes that may not be characterized as an income tax but rather as gross receipts or business use tax. Determine whether these other state taxes can be excluded.
  3. Negotiate the definition of non-recurring charges to exclude such items as pre-opening expenses, impairment charges or losses from discontinued operations. Ensure these items are clearly defined in the agreement.
  4. Negotiate the definition of rent to back out the non-cash portion representing the straight-line adjustment and tenant improvement allowance accretion required by GAAP. Rent should be reflective of the cash paid out.
Most lenders also will require a personal guarantee on the debt if the amount of equity is not significant or a limited history exists. A personal guarantee puts the individual’s personal assets at risk should the business not succeed and the underlying sale of assets fails to cover the debt owed. This risk can be mitigated through personal guarantee insurance, which may allow the guarantor to insure up to 70 percent of potential liability should the lender require the guarantor to make the debt obligation whole.

Debt negotiations can be difficult and time consuming; however, energy exerted upfront to clearly spell out the expectations and variables included in the financial covenant calculation can save significant time and money down the road, and allow you to focus on the growth of the company instead of continually negotiating with the lender to get back in compliance with the debt agreement.