Debt and Credit Markets

Credit agreement covenants that matter in a downturn

In a downturn, three features of a credit agreement decide what happens: whether the financial covenants are maintenance-tested or incurrence-tested, how EBITDA is defined inside the agreement rather than in the model, and who has the right to act on a default. Maintenance covenants are tested every quarter regardless of activity, so they trip first. Incurrence covenants only bind when the borrower takes an action, which means a declining business can breach nothing until it needs something.

• Ask which covenants can be tripped by the business simply getting worse. Maintenance tests bite automatically; incurrence tests only bind when you want to do something.
• Covenant-lite usually means no maintenance test on the term loan plus a springing test on the revolver — which can put the revolver lender in the only seat with live leverage.
• The EBITDA definition inside the agreement gives or takes more headroom than the ratio level does. Read it together with the compliance certificate.
• Coverage tests catch amortization that leverage tests ignore. An amortizing facility has less room to absorb an earnings decline than a bullet at the same multiple.
• The excess cash flow sweep decides whether a recovery deleverages the lender or funds your plan.
• Payment blockage and standstill live between the lenders, not in your credit agreement. In a unitranche you may not even be a party to the agreement that governs enforcement against you.
• The six-times leverage figure is historical supervisory framing. The OCC and FDIC rescinded the 2013 guidance on 5 December 2025 — source current capacity to dated market data instead.

Unitranche vs senior and mezzanine: how the stack gets chosen

A unitranche is a single blended facility that replaces a separate senior and subordinated structure, priced between the two and usually sliced internally into first-out and last-out tranches. A senior-plus-mezzanine structure keeps them separate: cheaper senior money, then subordinated debt carrying warrants. The choice turns on how many lender relationships you want to manage, how much certainty you need at close, and which provider is willing to underwrite your business at all.

• Order any capital structure by waterfall position first, then ask who provides each layer. The provider decides your covenants, your diligence burden and your workout behaviour.
• A unitranche does not remove complexity; it moves it into an agreement among lenders that the borrower is typically not a party to.
• An agreement among lenders sits inside one facility. An intercreditor agreement sits between separate facilities. They are not interchangeable.
• Where the structure is a single-lender unitranche plus a super-priority revolver, the revolver sits ahead of the unitranche in the waterfall.
• The mezzanine warrant closes the gap between the coupon a borrower can service and the return the lender needs. Negotiating the coupon alone rarely moves the total.
• Lenders count preferred equity as equity and mezzanine as debt for leverage purposes — which is frequently the entire reason one is chosen over the other.
• Under a government-guaranteed small-business acquisition loan, a seller note counts toward the required equity injection only on full standby for the life of the loan and only for at most half the injection.

Method The instrument table is ordered by waterfall position, not by cost, prevalence or preference, and the ordering comes from the graph rather than from editorial judgement. Each row states the confidence level and the sources behind its attributes.

Debt capacity: sizing leverage for an acquisition

Debt capacity for an acquisition is sized two ways, and the two do not agree. A leverage-multiple approach applies a multiple to adjusted EBITDA and is the cash-flow lending convention. A coverage approach asks whether cash available for debt service covers the required payments with a cushion, and it is what actually governs small acquisition loans, asset-based facilities and government-guaranteed structures. The two produce different answers on the same business, and the binding one is whichever your lender uses.

• Two sizing methods exist and they disagree systematically. Multiple-based sizing ignores everything below EBITDA; coverage-based sizing is what small acquisition loans actually run on.
• Capital-intensive and working-capital-hungry businesses support less debt than their EBITDA multiple implies. The gap is the cash costs the multiple ignores.
• Negotiate the EBITDA definition, not just the multiple. It governs every covenant test for the life of the facility and decides whether add-ons can be given pro-forma effect.
• Ask which lender types will look at this business before asking what leverage the market supports. Each type underwrites to a different constraint.
• Build the sources-and-uses table before the letter of intent. It is the arithmetic that decides whether the price is fundable at all.
• Under the small-business operating procedures effective 1 June 2025, a complete change of ownership needs a ten per cent minimum equity injection, and a standby seller note can fund at most half of it.
• Model the personal guaranty and the residence lien as real terms, not as paperwork. They change the risk of the transaction, not only its cost.
• Ability to pay is a bid ceiling, not a value. And six times total debt to EBITDA is historical supervisory framing — the guidance behind it was rescinded on 5 December 2025.

Method The worked example compares two sizing methods on identical inputs to isolate the difference between them. It asserts no multiple, cushion or advance rate, because the dossier establishes none, and directs current market levels to dated datasets with their vintage attached.