Covenants
Financial covenants
status: draft
Financial covenants
Financial covenants are originator-level tests of your balance sheet and income statement. Unlike portfolio covenants that measure collateral quality, financial covenants measure your ability to support the facility as a going concern. A breach signals distress at the company level, not just portfolio deterioration.
Capital providers care about financial covenants because asset-backed facilities are only partially asset-backed. The originator’s operational capacity, liquidity, and solvency determine whether the collateral can be serviced, whether representations remain valid, and whether the lender has a counterparty to work with if problems arise.
status: draft
The three core financial covenants
Nearly every ABF facility includes three financial covenants: tangible net worth, minimum liquidity, and maximum leverage.
Tangible net worth
Tangible net worth (TNW) is your equity minus intangible assets. It measures the hard asset cushion backing your operations.
Typical TNW definition:
"Tangible Net Worth" means, as of any date of determination, (i) total stockholders'
equity of the Originator and its consolidated Subsidiaries, minus (ii) the sum of
(a) goodwill, (b) intangible assets, (c) deferred tax assets, (d) loans or advances
to officers, directors or shareholders, and (e) intercompany receivables...What gets excluded (and surprises originators):
| Exclusion | Impact | How Much It Can Hurt |
|---|---|---|
| Goodwill | All acquisition premium excluded | Can reduce calculated TNW by 50%+ for acquirers |
| Intangible assets | Software, patents, customer relationships | 10-30% reduction for tech platforms |
| Deferred tax assets | Future tax benefits | 5-20% reduction depending on NOL carryforwards |
| Intercompany receivables | Amounts owed by affiliates | Can eliminate subsidiary value entirely |
| Restricted cash | Cash pledged to the facility | Reduces liquid cushion measure |
Before agreeing to a TNW covenant level, run the calculation under the deal’s specific definition. Your GAAP stockholders’ equity of $25M may calculate to $15M of Tangible Net Worth under the covenant definition.
Market benchmarks by originator type:
| Originator Type | Typical TNW Minimum | Setting Method |
|---|---|---|
| Early-stage fintech | $5M-$15M | Fixed dollar floor |
| Growth-stage consumer | $10M-$25M | 50-65% of closing TNW |
| Established equipment originator | $25M-$75M | 60-75% of closing TNW |
| Real estate bridge lender | $50M-$150M | Fixed floor or % of committed facility |
| Specialty finance company | $50M-$200M | Tied to AUM or facility size |
Minimum liquidity
Liquidity covenants ensure you can fund operations and meet near-term obligations without depending entirely on facility draws.
What counts as liquidity:
| Category | Usually Included | Sometimes Included | Usually Excluded |
|---|---|---|---|
| Cash | Unrestricted cash | Cash at subsidiaries | Restricted cash |
| Credit facilities | Undrawn committed revolver | Uncommitted lines | Delayed draw facilities |
| Marketable securities | Treasury bills, money market | Investment-grade bonds | Equity securities |
| Receivables | Short-term intercompany | Long-term receivables |
Typical market levels:
| Originator Type | Minimum Liquidity | Calculation Basis |
|---|---|---|
| Early-stage fintech | $2M-$5M | Fixed dollar |
| Growth-stage consumer | $5M-$10M | Fixed or % of AUM |
| Established originator | $10M-$25M | Greater of fixed and % of originations |
| Large specialty finance | $25M-$50M+ | % of committed facilities |
The definition of “unrestricted” matters. Cash trapped in facility accounts, margin deposits, or regulatory reserves typically doesn’t count. Read the liquidity definition carefully against your actual cash positioning.
Maximum leverage
Leverage covenants cap your total indebtedness relative to equity or earnings. They prevent you from becoming overleveraged at the corporate level.
Common leverage formulations:
| Ratio | Formula | Typical Cap |
|---|---|---|
| Debt to TNW | Total Debt / Tangible Net Worth | 3x-6x |
| Debt to Equity | Total Debt / Total Equity | 4x-8x |
| Debt to EBITDA | Total Debt / LTM EBITDA | 3x-5x |
| Senior Debt to EBITDA | Senior Debt / LTM EBITDA | 2x-4x |
Key exclusions to negotiate:
| Debt Type | Should Be Excluded? | Rationale |
|---|---|---|
| Non-recourse facility debt | Yes | Lender’s security, not your operating risk |
| Subordinated debt | Yes or partial | Equity-like in priority |
| Seller financing | Case by case | Depends on terms and maturity |
| Letters of credit | Usually no | Contingent but real obligation |
| Operating leases | Depends on accounting | Post-ASC 842, may be significant |
status: draft
How financial covenants are tested
Testing frequency and timing
| Covenant | Typical Testing | Reporting Deadline |
|---|---|---|
| TNW | Quarterly | 45-60 days after quarter end |
| Liquidity | Monthly or quarterly | 30-45 days after period end |
| Leverage | Quarterly | 45-60 days after quarter end |
“At all times” vs. “tested as of”:
- “Shall maintain at all times” means continuous compliance. A breach on any day is a breach, even if you’re compliant on the testing date.
- “Tested as of the last day of each fiscal quarter” means point-in-time compliance. You must be in compliance on the testing date, not necessarily every day.
Most TNW and leverage covenants use point-in-time testing. Liquidity covenants often require continuous compliance because liquidity can deteriorate rapidly.
The compliance certificate
Every quarter (sometimes monthly), you’ll sign a compliance certificate affirming that all covenants are satisfied. This is a legal representation, not a ministerial filing.
What you’re certifying:
- Financial statements are accurate and complete
- All covenant calculations are correct
- No Default or Event of Default exists
- All representations remain true
The risk of signing when breached:
Signing a compliance certificate when you know a covenant is breached is a misrepresentation. It can constitute an additional Event of Default and eliminate your cure rights. If you’re going to breach, disclose it in the certificate and begin the cure process—don’t certify compliance you don’t have.
status: draft
Negotiating financial covenants
Setting the right TNW floor
| Approach | How It Works | Risk |
|---|---|---|
| Fixed dollar minimum | Static floor (e.g., $12M) | Doesn’t grow with business; may become irrelevant |
| Percentage of closing TNW | 60-75% of TNW at close | Appropriate if you’re well-capitalized at close |
| Ratcheting minimum | Floor increases with origination volume | Equity in disguise—requires retained earnings or raises |
| Greater of fixed and % | Combines both approaches | Most common; provides both floor and proportionality |
What to avoid:
- TNW minimums that grow with facility size or origination volume (unless you’re actively raising equity)
- Definitions that exclude your invested capital in the SPV (this can swing your calculated TNW dramatically)
- Calculations that differ materially from your internal reporting (creates compliance tracking burden)
Liquidity definition negotiation
Push for a liquidity definition that matches your actual available resources:
| Element | Push For | Avoid |
|---|---|---|
| Committed facilities | Include undrawn committed capacity | Excluding all credit facilities |
| Subsidiary cash | Include if freely transferable | Excluding unless upstream clear |
| Marketable securities | Include treasury and investment-grade | Excluding entirely |
| Restricted cash | Exclude only cash pledged to this facility | Excluding all restricted balances |
Worked example—liquidity calculation:
| Line Item | Balance | Included? | Covenant Value |
|---|---|---|---|
| Operating cash | $4.2M | Yes | $4.2M |
| Money market funds | $2.1M | Yes | $2.1M |
| Facility reserve account | $1.5M | No (restricted) | $0 |
| Undrawn revolver (committed) | $5.0M | Yes | $5.0M |
| Term loan availability | $3.0M | No (uncommitted) | $0 |
| Total Liquidity | $15.8M | $11.3M |
If your covenant requires $8M liquidity, your $15.8M in apparent liquidity provides only $11.3M of covenant headroom—tighter than it looks.
Leverage exclusions
The most valuable negotiation is excluding non-recourse facility debt from the leverage calculation.
Argument for exclusion: The warehouse debt is secured by the collateral, non-recourse to the originator, and already subject to its own covenants. Including it in originator leverage double-counts the risk.
What capital providers may counter: They want visibility into total obligations. Compromise: exclude facility debt but include recourse obligations like personal guarantees or keepwell agreements.
status: draft
Cure rights and equity cures
Standard cure periods
| Covenant | Typical Cure Period | What Triggers the Clock |
|---|---|---|
| TNW | 30 days | Delivery of non-compliant financials |
| Liquidity | 10-15 business days | Falling below minimum |
| Leverage | 30 days | Delivery of non-compliant financials |
Equity cure mechanics
Most financial covenants allow an equity cure—injecting cash to bring the covenant back into compliance.
How equity cures typically work:
- You identify the covenant breach in the compliance certificate
- Within the cure period, you contribute cash to the originator
- The contribution is treated as equity for TNW calculation
- The contribution also adds to liquidity
- You must cure to compliance, not just to the threshold
Common limitations:
| Limitation | Typical Market |
|---|---|
| Maximum cures over facility life | 2-3 times |
| Minimum period between cures | 2-4 consecutive quarters |
| Cure amount requirement | Bring covenant to threshold plus 5-10% buffer |
| Source restrictions | Must be arm’s length equity, not subordinated debt |
Equity cures are a safety valve, not a business model. Capital providers track how many cures you’ve used and have remaining. Using them signals distress and typically triggers enhanced monitoring.
What happens if you don’t cure
If a financial covenant breach isn’t cured within the cure period, it becomes an Event of Default. The consequences escalate:
| Consequence | What It Means |
|---|---|
| Cash trapping | Waterfall directs all excess cash to principal paydown |
| Borrowing suspension | No new advances under the facility |
| Step-up pricing | Interest rate increases (often +200-400 bps) |
| Enhanced reporting | Weekly or daily collateral reports |
| Servicer replacement | Lender has right to appoint new servicer |
| Acceleration | Full principal becomes due immediately |
Not all consequences apply automatically. The credit agreement specifies which remedies are automatic vs. require lender election. Read the remedies section carefully.
status: draft
Benchmarks by originator type
Consumer fintech (early to growth stage)
| Covenant | Early Stage ($10M-$50M AUM) | Growth Stage ($50M-$200M AUM) |
|---|---|---|
| TNW minimum | $5M-$10M | $10M-$25M |
| Minimum liquidity | $2M-$4M | $5M-$10M |
| Max leverage (Debt/TNW) | 4x-6x | 5x-8x |
| Cure rights | 2 lifetime | 2-3 lifetime |
Equipment finance
| Covenant | Small Originator ($25M-$100M) | Mid-Market ($100M-$500M) |
|---|---|---|
| TNW minimum | $10M-$25M | $25M-$75M |
| Minimum liquidity | $3M-$8M | $10M-$25M |
| Max leverage (Debt/TNW) | 3x-5x | 4x-6x |
| Cure rights | 2-3 lifetime | 2-3 lifetime |
Real estate bridge lender
| Covenant | Emerging ($50M-$200M) | Established ($200M-$1B) |
|---|---|---|
| TNW minimum | $25M-$50M | $50M-$150M |
| Minimum liquidity | $5M-$15M | $15M-$40M |
| Max leverage (Debt/TNW) | 2x-4x | 3x-5x |
| Cure rights | 2 lifetime | 2-3 lifetime |
status: draft
Common pitfalls
Not running the calculation before signing. Your GAAP equity and the covenant’s Tangible Net Worth can differ by 25-50% depending on goodwill, intangibles, and deferred tax assets. Run the calculation under the covenant definition before you agree to the floor.
Treating equity cures as routine. Each cure reduces your remaining cure capacity and signals distress to the capital provider. If you’re projecting to need cures, either negotiate better covenant levels or raise equity.
Ignoring intercompany eliminations. If the covenant tests consolidated TNW, intercompany balances eliminate. But if it tests the originator entity specifically, intercompany receivables may be excluded as non-tangible. Understand the consolidation treatment.
Liquidity covenant during growth spurts. High-velocity originators can find liquidity tight during expansion periods even when profitable. The timing mismatch between origination cash outflows and facility advance receipts can stress liquidity covenants. Model your liquidity covenant across the origination cycle, not just at quarter-end.
Not understanding “at all times.” If your liquidity covenant requires compliance “at all times” and you dip below the threshold mid-month, you’ve breached—even if you’re compliant on the testing date. Continuous covenants require continuous monitoring.
Forgetting the compliance certificate is a representation. Every signature is a legal attestation. Build a compliance tracking system before closing and verify every covenant before you sign.
status: draft
Related topics
- Covenants overview — the five covenant categories and how they interact
- Portfolio covenants — collateral-level quality and concentration tests
- Covenant cures and waivers — cure mechanics, waiver process, and amendment costs
- Triggers, tests, and performance events — how covenant breaches cascade to facility triggers