Financial covenants: how to negotiate them with banks

What covenants are and why they matter

Covenants are contractual undertakings that the borrower (the company) gives to the banks. Their purpose is to protect the lenders against a deterioration in credit risk and to set a framework of financial prudence. But the specific drafting, in practice, determines the extent to which the company retains room to execute its strategy.

A common distinction is:

• Financial covenants: based on quantitative ratios (leverage, interest cover, liquidity, capitalisation, etc.) tested periodically using the financial statements.
• Non-financial or behavioural covenants: restrictions or conditions on key decisions (new indebtedness, security, asset disposals, dividends, information undertakings, change of control, etc.).

And by how they operate:

• Maintenance covenants: must be complied with continuously or on testing dates (e.g. Net Debt / EBITDA ≤ 3.5x each quarter).
• Incurrence covenants: tested only if the company takes a specified action (e.g. raising debt above a certain amount or paying extraordinary dividends).

In Spanish syndicated loans, classic maintenance covenants still dominate; in bilateral loans, their presence depends on transaction size, the sector and the company’s track record with the lender. For the entrepreneur and CFO, covenants are critical because they:

• define what the bank considers the “safe zone”;
• constrain future strategic decisions; and
• can trigger an event of default and potential acceleration if breached.

They are therefore not “small print”, but a central part of the financing negotiation.

Financial covenants: leverage and debt service capacity

The flagship financial covenant is Net Debt / EBITDA. It sets the maximum leverage the lenders will accept in light of the company’s operating cash generation capacity. Typically, a limit (3.0x, 3.5x, 4.0x, etc.) is set and must be respected on each test date.

What matters is not only the number, but the definitions:

• What is included in Net Debt: loans, revolving lines, recourse factoring, shareholder loans, leasing, other financial liabilities—and what is excluded.
• How EBITDA is calculated: whether adjustments are allowed for non-recurring costs, restructuring expenses, acquisition integration costs, etc.

That is where Maraz adds value: rather than simply trying to “push up” the covenant level, the objective is to ensure the ratio reflects the economic reality of the business and does not generate artificial breaches. It is common, for example, to negotiate:

• the treatment of certain instruments (non-recourse factoring, certain working-capital lines, leasing);
• grace periods following a major investment or acquisition, with slightly higher leverage levels initially;
• reasonable EBITDA adjustments aligned with market practice.

The second key financial covenant is interest cover, measuring how many times EBITDA covers finance costs. In a higher-rate environment, this ratio becomes more prominent. Before signing, the company should simulate:

• rate increases and their impact on cover;
• delays in projects that were expected to generate EBITDA.

Other possible financial covenants include minimum capitalisation ratios (equity / total assets), liquidity requirements, or limits on certain investments (CAPEX). Maraz’s comparative experience helps identify what is standard in similar deals and quickly flag requirements that exceed what is reasonable for the company’s risk profile.

Non-financial covenants: what the company can and cannot do

Non-financial covenants set the “rules of the game” during the life of the financing. In the Spanish market, the most common include:

• Restrictions on additional indebtedness: designed to prevent the company from taking on new debt with other creditors without control. These may be expressed as overall limits or as lists of “permitted debt” (working capital, leasing, non-recourse factoring, etc.).
• Negative pledge clause: prohibits granting security in favour of other creditors that would rank ahead of the financing banks, subject to exceptions (security required by law, security over the financed asset itself, reasonable amount thresholds).
• Restrictions on asset disposals: intended to prevent divestments that weaken the business. These often allow disposals of non-strategic assets up to a certain amount, or require proceeds to be used for debt repayment or reinvestment in productive assets.
• Limits on dividends and shareholder transactions: prevent cash leakage while leverage remains elevated. These are often linked to covenant compliance with an additional headroom buffer, or to annual distribution caps.
• Change of control and cross-default: a change of control may allow the banks to demand prepayment or renegotiation. A cross-default provision means that a material default with another creditor can also trigger a default here.

The key is for these clauses to be consistent with the strategic plan. Maraz helps align the two: if the company expects to sell a business unit, the documentation should reflect that; if the family intends to maintain a moderate dividend policy, restrictions should allow it provided solvency is preserved; if a future M&A transaction is contemplated, the change of control wording must be reviewed in detail.

Bilateral loan vs syndicated loan

In a bilateral loan, documentation is usually simpler and the relationship more personal. The bank uses standard templates, the number of covenants tends to be limited, and many matters are managed in practice through the relationship with the lender—even where there is a technical breach.

In a syndicated loan, by contrast, several banks, an agent and more extensive documentation come into play, often based on LMA-style standards. That typically implies:

• more detailed definitions of Net Debt, EBITDA, interest, etc.;
• a fuller package of financial and non-financial covenants;
• majority procedures to amend terms and grant waivers.

For a company entering its first syndication, it is strongly advisable to have an adviser such as Maraz both at term sheet stage (where the covenant “skeleton” is set) and at documentation stage (where the real detail is negotiated).

How to negotiate covenants with the banks: priorities and strategy

Negotiating covenants is not about trying to delete them from the contract. It is about prioritising them and tailoring their design to the reality of the business.

A sound strategy usually involves:

1. Define the target picture before meeting the bank: be clear on the 3–5 year business plan, the leverage path, investment needs, dividend expectations and any potential M&A. This allows you to request a covenant package that matches that roadmap.
2. Separate what is essential from what is negotiable: some covenants are practically unavoidable (leverage, cover, periodic information, a basic negative pledge, change of control). The negotiation lies in levels, exceptions and technical detail. Others are more flexible: specific dividend limits, additional debt baskets, asset disposal permissions, and mechanisms such as equity cure (the ability for shareholders to inject funds to remedy a one-off breach).
3. Treat definitions as seriously as the numbers: sometimes how a ratio is measured matters more than the number itself. An overly narrow EBITDA definition or Net Debt definition that captures operating liabilities can make an apparently reasonable covenant unworkable.
4. Speak the bank’s language: banks think in terms of risk and repayment capacity. Maraz helps structure the negotiation with financial models and scenarios showing why certain levels and exceptions are prudent and reasonable from a risk perspective.

In practice, Maraz prepares the company’s “case” (model, scenarios, covenant proposal) and supports management in meetings with the lenders, acting as a translator between business logic and banking logic—and avoiding undertakings that later suffocate flexibility.

Managing breaches and waivers: definition, anticipation and solutions

Even with a well-designed covenant package, situations can arise where a breach becomes foreseeable: a sharp drop in sales, a rapid increase in rates, a delayed project. The impulsive reaction is often to wait “to see if the quarter can be saved”. That is almost always a mistake.

First, it is important to be clear on what a waiver is: a waiver is the express written renunciation by a creditor (normally the banks) of exercising a contractual right, usually as a consequence of a borrower default.

Applied to covenants:

• If the company breaches a covenant (for example, exceeds the Net Debt / EBITDA limit), the bank has the right to accelerate, increase the margin, require additional security, etc.
• A waiver is the agreement under which the banks acknowledge the breach but waive, in whole or in part, those consequences—typically subject to conditions (fees, enhanced security, equity injection, tightening of other covenants, etc.).

A waiver may be:

• One-off: a specific breach is forgiven on a specific test date.
• Temporary: covenant levels are relaxed for a period, with a timetable back to “normal”.
• Conditional: linked to executing an action plan (divestment, capital increase, cost measures, etc.).

Managing a potential breach effectively comes down to three key principles:

1. Anticipation: covenants should be integrated into the company’s internal dashboard. It makes no sense to discover the issue only at month-end close. Maraz can help implement periodic monitoring so you can see—months in advance—whether a ratio will tighten.
2. Diagnosis and action plan: quantify the deviation and determine whether it is one-off or structural. Then prepare a plan: internal measures, non-strategic divestments, equity or subordinated funding, partial refinancing, maturity rebalancing, etc. The more concrete and credible the plan, the easier the negotiation.
3. Transparency and waiver negotiation: with the numbers and the plan in hand, you engage the banks before the breach becomes official. In bilateral facilities, waivers can often be processed relatively quickly; in syndicated loans, they require lender majorities and often involve compensating measures.

Banks’ attitude changes materially when they see early action, complete and consistent information, and real commitment from shareholders and management.

Maraz supports the company throughout: from identifying covenant pressure, to preparing the documentation and negotiating the waiver technically—seeking to resolve the immediate issue without damaging the lender relationship and, where possible, strengthening mutual confidence.

Conclusion

Financial covenants are not “small print”; they are an essential element of the company’s financial architecture. For family-owned and mid-sized businesses, managing them well is critical to grow, invest and pursue M&A without unpleasant surprises. Designing a balanced covenant package, knowing what to accept and what to negotiate, monitoring compliance closely, and responding early and transparently to emerging pressure is now part of professional financial management.

That is where Maraz Corporate Finance can add distinctive value:

• structuring the financing coherently with the company’s strategy;
• negotiating covenants that protect the bank without choking business flexibility;
• implementing monitoring that anticipates issues;
• leading waiver negotiations and covenant resets when needed.

Negotiating covenants properly enables the company to secure stable financing for its growth plans while preserving the manoeuvring room a business needs. That is where Maraz’s advice can make the difference.

Javier de Rojas Roca de Togores

Partner - Maraz Corporate Finance