Why covenants matter to a first-time founder
Covenants can restrict dividends, further borrowing, asset sales, or other decisions long before a loan is due. They may also require reports or minimum financial ratios. A breach can trigger fees, renegotiation, or default rights, so founders must model the terms rather than treating them as boilerplate.
Examples of covenants
A loan requires interest coverage above 2.0. If operating profit used by the agreement is £120,000 and interest is £50,000, coverage is 2.4. A fall to £90,000 produces 1.8 and breaches the covenant unless the lender waives it. The contract’s exact definitions control the calculation.
Common misunderstanding
A covenant is not the same as a repayment instalment. It is a promise or condition governing conduct, information, or financial position. Positive covenants require action; negative covenants restrict it. Definitions, testing dates, remedies, and waiver rules vary by agreement and jurisdiction, even when labels look familiar.
When to use it
Review covenants before accepting debt, making distributions, raising more finance, or selling important assets. Build each test into monthly forecasts with headroom and warning thresholds. If a breach seems possible, speak to the lender early and obtain legal and financial advice; silence rarely improves the available options.