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Debt Covenants

Loan Covenants – Challenges and Options to Consider

By Tom Bartos

A common concern with business loans is covenant compliance. Does my business loan have covenants and if so, what are the compliance requirements? Smaller loans under $100,000 may not require collateral, and are usually free of any covenants, but as businesses grow, so do their financing needs. Business owners looking to borrow over $500,000 can expect the loan agreement to contain some type of covenants or compliance requirements. The covenants typically are either financial, operating, reporting or restrictive in nature. Examples of each are maintaining a minimum cash flow to debt ratio (financial), carrying a minimum level of insurance (operating), submitting financial statements to the lender (reporting), and limiting dividends or payments to shareholders or owners (restrictive).

The covenants are in effect while the loan agreement is in place, and require compliance to be reported to the lender on a quarterly, semi-annual, or annual basis. They provide lenders certain financial and business protections in addition to their rights to the collateral, plus provide information regarding any possible adverse changes in the borrower’s financial condition. In other words, covenants provide an additional security blanket for the lender and serve as an early indicator of possible financial issues on the horizon.

Covenants are written as affirmative actions or negative requirements. Affirmative and negative covenants take on many forms. Affirmative covenants require the company to adhere to certain predefined promises, rules, or regulations. These covenants are written into the loan agreement for the benefit of the lenders, shareholders, and other stakeholders. Examples include requiring the company to maintain certain levels of insurance or paying all taxes on time. Negative covenants restrict a company from engaging in certain activities, such as restricting the payment of dividends to shareholders while the debt is outstanding, or purchasing an unrelated business.

 

What are Your Options?

A business owner has to live with the terms of the loan agreement while the loan is outstanding, therefore it is best to determine the company’s future or forecasted ability to comply with the covenants prior to the agreement’s execution. Forward looking projections are important to avoid a potential covenant default and an uncomfortable discussion with the lender at a later date. If a business owner is uncertain as to future compliance with any of the covenants prior to closing, the issue should be discussed and negotiated with the lender beforehand.

Another negotiating topic with the lender surrounding the covenants is the potential for avoiding or removing personal guarantees. Small businesses can have personal guarantees, if present in the agreement, removed after a period of covenant compliance, or avoid personal guarantees with tighter covenants.

 

 

Dealing with Compliance Challenges

If a business finds itself in a covenant violation, the borrow may have a cure period to rectify the violation, if it can be corrected. A cure period for covenant violations will be specified in the loan agreement. Not all covenant violations can be cured or can be cured within the time specified in the loan agreement, so it is best to proactively monitor covenant compliance throughout the year. As is the case with covenants, the ability and time frame to cure defaults can be negotiated into the loan agreement before it is finalized. In the unfortunate instance where a covenant default cannot be avoided, the borrower should notify the lender in accordance with the notice provisions in the loan agreement. The lender may grant a waiver, effectively stating that the lender will not take any actions as a result of the default for a period of time. If the lender does not grant a waiver, their actions can include increasing the interest rates, accelerating the maturity of the loan, or calling the loan to be due immediately.

When entering into loan negotiations with a lender, it is best to obtain advice and assistance from experienced advisers such as a CFO and a good corporate attorney who is experienced in negotiating bank transactions. These professionals will act as a team by adding value in the negotiations, helping everyone understand the various terms and conditions of the agreement, including the covenant provisions, and assist in the loan agreement’s ongoing compliance. Upfront planning, timely compliance, and having the right people and reporting systems in place can avoid covenant compliance issues in the future.

 

Tom is an Area President for FocusCFO based in Pittsburgh, PA.

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Forge and Finance

Forge and Finance

By Peter Geise

Recently I was asked to write a quarterly column on financial matters for Forge Magazine. As the name suggests, the magazine serves the forging industry, which is a $36.6B industry that is growing at a modest rate of 1.2% annually. Forging is big business in NE Ohio, where I live, with several companies like Sifco Industries, Wyman-Gordon Forgings, Wiseco, Dyson Corp., Wodin, Viking Forge, Solmet, Ohio Star Forge, Bula Forge, Ken Forging and Canton Drop Forge headquartered here. 

In my column, I’m hoping to provide some thoughts and tips to business owners, including how to evaluate and minimize risk, improve and manage cash flow, and how to add value. I also hope to hear from the Forge readers on topics they’d like me to cover.

Stay tuned!

Peter is an Area President for FocusCFO based out of Akron, OH.

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Jayme Burgman

Welcome Jayme Burgman

Welcome to Focus CFO

Jayme has been a senior executive and business founder with experience in both finance and operations for more than 30 years. He has experience leading finance and accounting strategy for diverse companies across the ancillary health care, commercial, and not-for-profit sectors.

Jayme and his wife Carol live south of Pittsburgh.

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Richard Burns

Welcome Richard Burns

Welcome to the FocusCFO Team!

Richard has more than 30 years of executive management and leadership experience Management expertise in sales, marketing, operations, supply chain, technology, finance, strategic planning, organizational development and quality assurance. He has worked with thousands of customers across many industries including industrial, electrical, automotive, consumer and medical markets. Richard and his wife Donna live in Brecksville, Ohio.

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Professional Concepts Insurance Agency Testimonial

Professional Concepts Insurance Agency Testimonial

“PCIA believes in a laser focus on growth and opportunities.  Lesli Funk Matukaitis and FocusCFO have allowed our organization to focus “on the business.”   Every week, our CFO, from FocusCFO, spends a full day in our office strategizing and looking for unforeseen opportunities for financial growth at PCIA.  We enjoy our opportunity with FocusCFO and look forward to continuing our success.”

Michael Cosgrove, President of Professional Concepts Insurance Agency
February 2020

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