Maintenance covenants require the borrower to maintain a certain ratio or metric at all times. This is required by lenders because they want to make sure the company is in good shape to pay interest and pay back the principal.
Common maintenance covenants include:
- Senior Debt Leverage Ratio: Senior debt to EBITDA
- Leverage Ratio: Total debt to EBITDA
- Fixed Charge Coverage Ratio: (EBITDA – Capex) / (Interest Expense + Mandatory Amortization of Debt)
Incurrence covenants are restrictions on specific actions – usually related to dividends, debt, expansion, or acquisitions – since any of these actions could materially affect a company’s ability to meet interest payments. For example, lenders may dictate that the company is not allowed to pay dividends until fully retiring the senior debt, or to take no new debt unless the borrower’s debt to EBITDA ratio is less than a certain ratio such as 5.0x.