The Art of the Covenant:
Everything you Need to Know about Loan Covenants.
Source: Jill Andresky Fraser, 1 August 1997
Two years ago Allen Systems Group Inc., a com-
puter-software manufacturer based in Naples, Fla.,
was almost ready to sign a new credit agreement. But
its chief financial officer, Frederick Roberts, was
concerned about an essential yet often-overlooked
component of the deal: the loan covenants.
"Our banker wanted to include some very strict cove-
nants regarding the company's key financial ratios,"
Roberts recalls. Those covenants "would have wound
up hampering our ability to grow, because they
would have prevented us from acquiring some impor-
tant new software products. Each acquisition would
have put us temporarily out of compliance."
Roberts was determined to negotiate the $23-million
company's way out of those requirements--or seek
financing elsewhere. "Too many entrepreneurs get
ecstatic just over the act of qualifying for bank fund-
ing--but then fail to pay attention to the fine print of
the loan agreement," he says. "If you're not watching
and you fall out of compliance with a covenant, you
run a very powerful risk of getting your loan called
in, whether you're up-to-date on your payments or
Loan-covenant problems are fairly common for fast-
growing companies, whose financial statements sel-
dom conform to a banker's ideal vision of fiscal
health. Roberts, armed with short- and long-term fi-
nancial projections, eventually won "more appropri-
ate" terms, as he puts it. But many other companies
either don't try to change their bank covenants or
don't worry about future problems those covenants
Would your own approach have been simply to sign
up, close the loan, and hope for the best? Then it's
time for Inc.'s quick primer on loan covenants. Don't
visit your banker without it.
MYTH: With bank financing, all that matters is the
REALITY: Many banking experts believe that inter-
est charges are among the least important features of
a loan. "After all, interest is a deductible business
expense, so the government is really helping you
handle it," notes George M. Dawson, a banking con-
sultant based in San Antonio, Tex.
Loan covenants, on the other hand, are extremely