Financial covenants clause: Copy, customize, and use instantly
Introduction
A financial covenants clause sets specific financial responsibilities or benchmarks that a party must meet during the term of an agreement, often found in loan agreements or credit facilities. These covenants are designed to ensure the financial stability of the borrower and protect the lender’s interests. They typically cover metrics like debt-to-equity ratio, EBITDA thresholds, or liquidity requirements.Below are templates for financial covenants clauses tailored to different scenarios. Copy, customize, and insert them into your agreement.
Debt-to-equity ratio requirement
This clause ensures the borrower maintains a healthy balance between debt and equity.
The borrower agrees to maintain a debt-to-equity ratio not exceeding [specific ratio, e.g., 3:1] throughout the term of this Agreement. The ratio will be calculated quarterly based on the borrower’s consolidated financial statements.
Minimum EBITDA threshold
This clause requires the borrower to maintain a minimum EBITDA level.
The borrower shall achieve and maintain a minimum EBITDA of [specific amount, e.g., $2,000,000] on a rolling twelve-month basis. Compliance will be tested quarterly based on the borrower’s financial reports.
Interest coverage ratio
This clause requires the borrower to ensure sufficient earnings to cover interest obligations.
The borrower must maintain an interest coverage ratio of at least [specific ratio, e.g., 4:1] during the term of the Agreement. The ratio shall be calculated as EBITDA divided by total interest expenses, reviewed quarterly.
Liquidity maintenance
This clause mandates the borrower to sustain minimum liquidity levels.
The borrower agrees to maintain a minimum liquidity level of [specific amount, e.g., $500,000] in unrestricted cash or cash equivalents. This requirement shall be tested monthly and reported to the lender.
Leverage ratio restriction
This clause limits the borrower’s leverage to protect the lender’s exposure.
The borrower shall ensure that the total debt-to-EBITDA ratio does not exceed [specific ratio, e.g., 5.0] at any time during the term of this Agreement. Non-compliance will trigger corrective actions as outlined herein.
Capital expenditure cap
This clause restricts the borrower’s capital expenditures to a set limit.
The borrower agrees not to incur capital expenditures exceeding [specific amount, e.g., $1,000,000] in any fiscal year without prior written consent from the lender.
Dividend restriction
This clause limits the borrower’s ability to pay dividends under certain conditions.
The borrower shall not declare or pay any dividends if doing so would cause a breach of the financial covenants set forth in this Agreement. All dividend payments must be approved in advance by the lender.
Fixed charge coverage ratio
This clause ensures the borrower can cover fixed charges with available earnings.
The borrower agrees to maintain a fixed charge coverage ratio of at least [specific ratio, e.g., 1.5:1] during the term of the Agreement. This ratio shall be tested semi-annually based on the borrower’s financial statements.
Current ratio requirement
This clause mandates a specific level of liquidity to meet short-term obligations.
The borrower must maintain a current ratio of no less than [specific ratio, e.g., 1.2:1] at all times. The ratio shall be calculated as current assets divided by current liabilities and tested quarterly.
Net worth covenant
This clause requires the borrower to maintain a minimum net worth.
The borrower agrees to maintain a minimum net worth of [specific amount, e.g., $10,000,000] throughout the term of the Agreement. This covenant shall be tested annually based on audited financial statements.
Cash flow coverage ratio
This clause ensures the borrower generates sufficient cash flow to cover obligations.
The borrower must maintain a cash flow coverage ratio of at least [specific ratio, e.g., 1.2:1] at all times during the term of this Agreement. The ratio shall be calculated as operating cash flow divided by total debt service obligations and reviewed quarterly.
Maximum debt covenant
This clause limits the total amount of debt the borrower can incur.
The borrower agrees not to incur total debt exceeding [specific amount, e.g., $5,000,000] at any time during the term of this Agreement, unless explicitly approved in writing by the lender.
Accounts receivable turnover ratio
This clause requires the borrower to maintain efficient collection of receivables.
The borrower must maintain an accounts receivable turnover ratio of at least [specific ratio, e.g., 6 times annually]. Compliance will be tested quarterly based on financial statements.
Equity injection requirement
This clause requires the borrower to inject additional equity under certain conditions.
The borrower agrees to provide an equity injection of [specific amount, e.g., $1,000,000] within [specific time frame, e.g., 30 days] if the debt-to-equity ratio exceeds [specific threshold, e.g., 4:1].
Inventory turnover ratio
This clause mandates efficient inventory management.
The borrower must maintain an inventory turnover ratio of at least [specific ratio, e.g., 5 times annually], calculated as cost of goods sold divided by average inventory. This ratio shall be tested semi-annually.
Restricted payments covenant
This clause restricts certain payments by the borrower.
The borrower shall not make any restricted payments, including loans or advances to affiliates or significant shareholders, without the prior written consent of the lender, unless the financial covenants are fully met.
Annual profitability covenant
This clause requires the borrower to maintain profitability.
The borrower agrees to achieve and sustain an annual net profit of at least [specific amount, e.g., $500,000] for each fiscal year during the term of this Agreement. Compliance will be tested based on audited annual financial statements.
Working capital maintenance
This clause ensures the borrower maintains sufficient working capital.
The borrower must maintain a minimum working capital of [specific amount, e.g., $1,500,000] at all times, calculated as current assets minus current liabilities. This requirement will be reviewed quarterly.
Fixed asset ratio
This clause mandates maintaining a specific ratio of fixed assets to liabilities.
The borrower agrees to maintain a fixed asset ratio of at least [specific ratio, e.g., 1.5:1], calculated as net fixed assets divided by total liabilities. This ratio shall be reviewed semi-annually.
Early repayment covenant
This clause requires early repayment if financial benchmarks are not met.
The borrower shall make an early repayment of [specific percentage, e.g., 10% of outstanding principal] within [specific time frame, e.g., 30 days] if any financial covenants are breached, unless waived by the lender.
Debt service coverage ratio
This clause ensures the borrower has adequate earnings to cover debt obligations.
The borrower must maintain a debt service coverage ratio of at least [specific ratio, e.g., 1.25:1] at all times during the Agreement. This ratio shall be tested semi-annually, based on EBITDA and total debt service obligations.
Quarterly revenue covenant
This clause mandates maintaining a minimum revenue level on a quarterly basis.
The borrower agrees to generate a minimum revenue of [specific amount, e.g., $1,000,000] per quarter during the term of the Agreement. Quarterly compliance will be verified using unaudited financial statements.
Capital adequacy covenant
This clause ensures the borrower maintains sufficient capital reserves.
The borrower must maintain a minimum capital adequacy ratio of [specific percentage, e.g., 10%], calculated as total equity divided by total risk-weighted assets. Compliance will be tested annually.
Investment restriction covenant
This clause limits the borrower’s ability to make certain investments.
The borrower shall not make any new investments exceeding [specific amount, e.g., $250,000] in any fiscal year without prior written approval from the lender, except as provided in the attached schedule.
Operating margin covenant
This clause requires the borrower to maintain a specific operating margin.
The borrower agrees to achieve and sustain an operating margin of at least [specific percentage, e.g., 15%] during the term of this Agreement. Compliance will be tested semi-annually based on operating income and total revenue.
Non-core asset sale restriction
This clause limits the borrower’s ability to sell non-core assets.
The borrower shall not sell or dispose of non-core assets valued at more than [specific amount, e.g., $500,000] during the term of this Agreement without prior lender approval.
Debt maturity alignment
This clause ensures alignment of debt maturity with financial obligations.
The borrower agrees to align the maturity of new debt with its cash flow projections, ensuring no more than [specific percentage, e.g., 30%] of total debt matures within any fiscal year.
Guarantee coverage requirement
This clause mandates the borrower to maintain third-party guarantees.
The borrower must ensure third-party guarantees cover at least [specific percentage, e.g., 80%] of the outstanding principal amount under this Agreement. Compliance will be reviewed annually.
Performance bond requirement
This clause requires the borrower to provide a performance bond.
The borrower agrees to provide a performance bond valued at [specific amount, e.g., $1,000,000] to secure obligations under this Agreement. The bond must remain valid throughout the loan term.
Gross profit margin covenant
This clause requires the borrower to maintain a specific gross profit margin.
The borrower agrees to sustain a gross profit margin of at least [specific percentage, e.g., 25%] during the term of this Agreement. This shall be calculated as gross profit divided by total revenue and reviewed quarterly.
Dividend payout ratio covenant
This clause limits the borrower’s dividend payouts relative to earnings.
The borrower shall not declare or distribute dividends exceeding [specific percentage, e.g., 50%] of net earnings for any fiscal year unless all financial covenants are fully met and prior approval is obtained from the lender.
Loan-to-value ratio covenant
This clause mandates maintaining a specific loan-to-value ratio.
The borrower agrees to maintain a loan-to-value ratio not exceeding [specific percentage, e.g., 70%]. This ratio will be calculated quarterly, based on the appraised value of collateral and the outstanding loan balance.
Retained earnings covenant
This clause requires the borrower to retain a minimum level of earnings.
The borrower must retain a minimum of [specific amount, e.g., $2,000,000] in cumulative earnings during the term of this Agreement. Annual compliance will be verified using audited financial statements.
Restricted asset transfer covenant
This clause limits the borrower’s ability to transfer or encumber assets.
The borrower shall not transfer, sell, or encumber any significant assets exceeding [specific amount, e.g., $1,000,000] without prior written consent from the lender, unless expressly allowed under this Agreement.
Annual growth rate covenant
This clause requires the borrower to achieve a specified annual growth rate.
The borrower agrees to maintain an annual revenue growth rate of at least [specific percentage, e.g., 10%] during the term of this Agreement. Compliance will be measured based on year-over-year comparisons of audited financial statements.
Covenant cure period clause
This clause allows a grace period to rectify covenant breaches.
In the event of a breach of any financial covenant, the borrower shall have [specific time frame, e.g., 30 days] from the date of notification to cure the breach. Failure to do so will result in default under this Agreement.
Revenue concentration covenant
This clause restricts the borrower’s reliance on a single customer or industry.
The borrower shall ensure that no more than [specific percentage, e.g., 30%] of total revenue is derived from any single customer or industry sector to mitigate concentration risk.
EBITDA margin covenant
This clause mandates a minimum EBITDA margin level.
The borrower agrees to maintain an EBITDA margin of at least [specific percentage, e.g., 20%] throughout the term of this Agreement. Quarterly compliance will be tested based on financial statements.
Unsecured debt limitation covenant
This clause limits the amount of unsecured debt the borrower can incur.
The borrower shall not incur unsecured debt exceeding [specific amount, e.g., $500,000] without prior written approval from the lender.
Lease payment ratio covenant
This clause ensures lease payment obligations remain sustainable.
The borrower agrees to maintain a lease payment-to-revenue ratio of no more than [specific percentage, e.g., 10%], calculated annually based on financial statements.
Operational cash flow covenant
This clause requires the borrower to maintain positive operational cash flow.
The borrower must generate positive operational cash flow of at least [specific amount, e.g., $100,000] per quarter. Compliance will be reviewed quarterly based on cash flow statements.
Depreciation and amortization limit covenant
This clause limits the amount of depreciation and amortization expenses.
The borrower agrees that total depreciation and amortization expenses shall not exceed [specific amount, e.g., $500,000] annually, to ensure sustainable financial performance.
Fixed asset investment covenant
This clause requires maintaining a minimum level of fixed asset investments.
The borrower must invest at least [specific amount, e.g., $1,000,000] annually in fixed assets to ensure operational capacity and growth.
Affiliate transaction restriction covenant
This clause limits transactions with related parties.
The borrower shall not engage in transactions with affiliates or related parties exceeding [specific amount, e.g., $250,000] annually without prior lender approval and disclosure.
Hedging requirement covenant
This clause mandates the borrower to engage in hedging to mitigate risks.
The borrower agrees to implement appropriate hedging strategies for [specific risks, e.g., currency or interest rate fluctuations] and maintain documentation to demonstrate compliance.
Asset coverage ratio covenant
This clause requires maintaining a minimum asset coverage ratio.
The borrower must maintain an asset coverage ratio of at least [specific ratio, e.g., 1.5:1], calculated as total assets divided by total liabilities. Compliance will be tested semi-annually.
Prepayment limitation covenant
This clause restricts prepayments unless certain conditions are met.
The borrower shall not make prepayments exceeding [specific percentage, e.g., 20% of the outstanding balance] in any fiscal year unless all financial covenants are fully met.
Compliance certificate submission covenant
This clause requires regular submission of compliance certificates.
The borrower agrees to submit compliance certificates, certified by a financial officer, confirming adherence to all financial covenants on a [specific frequency, e.g., quarterly] basis.
Revenue diversification covenant
This clause requires the borrower to diversify revenue sources.
The borrower must ensure that revenue from any single product or service does not exceed [specific percentage, e.g., 50%] of total revenue to mitigate risk. Compliance will be reviewed annually.
Subordination of additional debt covenant
This clause requires any new debt to be subordinated to the existing loan.
The borrower agrees that any additional debt incurred during the term of this Agreement shall be subordinated to the existing loan, ensuring the lender’s priority in repayment.
Financial reporting timeline covenant
This clause mandates timely submission of financial reports.
The borrower shall submit audited financial statements within [specific time frame, e.g., 90 days] of the end of each fiscal year and quarterly statements within [specific time frame, e.g., 30 days] of the end of each quarter.
Inventory valuation method covenant
This clause ensures consistency in inventory valuation methods.
The borrower agrees to use the [specific method, e.g., FIFO or LIFO] method of inventory valuation consistently throughout the term of this Agreement and shall not make changes without prior lender approval.
Deferred revenue restriction covenant
This clause restricts excessive deferrals of revenue recognition.
The borrower shall not defer revenue recognition beyond [specific time frame, e.g., 12 months] unless such deferral complies with generally accepted accounting principles (GAAP) and is disclosed to the lender.
Prohibition on speculative investments covenant
This clause restricts speculative financial investments.
The borrower agrees not to engage in speculative investments, including but not limited to derivatives or high-risk securities, unless expressly approved by the lender.
Restricted cash reserve covenant
This clause requires maintaining a restricted cash reserve for emergencies.
The borrower must maintain a restricted cash reserve of at least [specific amount, e.g., $500,000] to cover unforeseen expenses. This reserve shall not be used without prior written consent from the lender.
Currency risk mitigation covenant
This clause mandates strategies to mitigate currency exchange risks.
The borrower shall implement currency risk mitigation measures, including hedging, for any transactions exceeding [specific amount, e.g., $1,000,000] conducted in foreign currencies.
Collateral appraisal frequency covenant
This clause requires periodic appraisals of pledged collateral.
The borrower agrees to submit the pledged collateral for appraisal every [specific time frame, e.g., 12 months] to ensure the lender’s security interest is adequately protected.
Key personnel retention covenant
This clause requires the borrower to retain critical employees.
The borrower shall ensure the retention of [specific key personnel, e.g., CEO or CFO] during the term of this Agreement. Any changes in key personnel must be communicated to the lender within [specific time frame, e.g., 10 days].
Insurance coverage maintenance covenant
This clause mandates specific insurance policies for risk coverage.
The borrower agrees to maintain insurance coverage, including [specific policies, e.g., property, liability, or business interruption insurance], with a minimum coverage amount of [specific amount, e.g., $2,000,000].
Amortization schedule adherence covenant
This clause requires strict adherence to the loan amortization schedule.
The borrower shall adhere to the amortization schedule outlined in this Agreement, with no deviations or adjustments without prior written consent from the lender.
Performance guarantees covenant
This clause mandates providing guarantees for critical project milestones.
The borrower agrees to provide performance guarantees for projects exceeding [specific value, e.g., $500,000], ensuring timely completion and quality standards.
Accounts payable aging covenant
This clause restricts overdue accounts payable.
The borrower shall ensure that no more than [specific percentage, e.g., 10%] of accounts payable remain overdue for longer than [specific time frame, e.g., 90 days]. Compliance will be reviewed quarterly.
Tax compliance covenant
This clause requires adherence to tax filing and payment obligations.
The borrower agrees to remain compliant with all tax filing and payment obligations, ensuring no tax liens or overdue liabilities exist during the term of this Agreement.
Environmental compliance covenant
This clause ensures adherence to environmental regulations.
The borrower must comply with all applicable environmental laws and regulations. Any violations must be reported to the lender within [specific time frame, e.g., 15 days] of discovery.
Business interruption contingency covenant
This clause requires a plan for business continuity during interruptions.
The borrower agrees to maintain a business continuity plan, including financial contingencies, to address potential operational interruptions exceeding [specific duration, e.g., 72 hours].
Affiliate guarantee covenant
This clause requires guarantees from affiliated entities.
The borrower shall provide guarantees from affiliated entities for obligations exceeding [specific amount, e.g., $1,000,000], ensuring additional security for the lender.
Fixed-cost limitation covenant
This clause limits the borrower’s fixed operating costs.
The borrower agrees not to increase fixed operating costs by more than [specific percentage, e.g., 5% annually] without prior written consent from the lender.
Performance-based fee covenant
This clause restricts performance-based fees during financial instability.
The borrower shall not pay performance-based fees, including bonuses or commissions, exceeding [specific percentage, e.g., 10% of net revenue] if any financial covenants are breached.
Escrow for capital expenditures covenant
This clause requires an escrow account for significant capital expenditures.
The borrower agrees to establish an escrow account for capital expenditures exceeding [specific amount, e.g., $1,000,000], ensuring funds are allocated and used as agreed upon with the lender.
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