Managing your Lender through a busted Covenant

In the world of business acquisition lending, covenants are often broken. It happens so frequently it appears that covenants were made to be broken. Rarely do companies get through a lending cycle without busting one or two important covenants along the way.

The question is not will you break a covenant, but how will you handle the breaking of the covenant with your lender. Will you wait to the last minute? Will you tell them casually and tell them not to worry? Will you tell them right away and provide additional business updates to mitigate their concern?

The when and how are important variables and depend on the type of relationship you have with your lender. Let’s start with a few basic points of lending that inform this communication exercise. Business acquisition lenders hate surprises, and always want to feel as if you are in control of whatever problem there is.

A serious covenant default, such as a fixed charge ratio breach, means you don’t have enough money to repay your loan. This gives your lender serious pause for concern. We’ve dealt with over 70 covenant situations over the past 28 years and have learned a thing or two about the best way to handle it.

1. Be honest about the miss – sometimes a faulty covenant is set. Other times, the business clearly underperforms. Make sure you diagnose the situation properly and don’t make a bad situation worse by misattributing the causes of the miss.
2. Get out in front of the issue – Lenders like proactive management teams, that take ownership over an issue with a view toward rectifying it. Lender’s also are smart enough to know that the issue can be an industry one, the company cannot possibly avoid. It is always best to go to them as early as you know you have a covenant problem and let them know you are on top of it.
3. Have a plan to rectify the deficiency – Having a plan establishes your control over remedying the issue. It builds their confidence and buys you time to manage through the turbulence.
4. Be realistic about short term performance – its important to realize that this might not be rectified overnight so you should be conservative about the turnaround time. You will undermine your credibility if you say it will be fixed in a week and takes a quarter.
5. Balance the news with something positive – your lender must go to his boss and say why he thinks things will work out. Give him something to work with so that he can sell it up the line.
6. Emphasize the human touch – bad news is best delivered over a nice lunch or at least in person. Your tone, modulation and positive spirit will help stabilize the discussion and allow you to assess their real level of concern.