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What are debt covenants?

A debt covenant is typically attached to any loan agreement between a lender and a borrow. Debt covenants are basically rules that the borrower must follow. If the borrow doesn’t follow the rules, then they would violate their debt covenants, which could require the borrower to repay the loan in full immediately.

Some common examples of ratios/metrics included in debt covenants include debt to EBITDA, debt to equity, total assets, etc. For example, the debt covenant could say that the borrow must maintain a debt to EBITDA ratio that is greater than 5.0. If the ratio drops below 5.0, then the borrow would be in default of the debt covenants.

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  • What does it mean to be in violation of the debt covenants?

    Debt covenants are rules set by the lender (creditor) that the borrow (debtor) must follow. For example, let’s say that the borrow is required to maintain total assets of $5 million or greater. If total assets drops below $5 million, the borrow would be violating the debt covenants and they could be required to repay the loan immediately or incur additional fees/penalties.

  • What is the difference between a debtor and a creditor?

    When a company borrows money, they are considered the debtor, or the borrower. The debtor would borrow money from the creditor, or lender (i.e. a bank). The debtor borrows cash from lender for a set period of time and will likely pay the lender interest.