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Sandor Jacobson Shawn Dubinsky
January 30, 2019 Article 4 min read

If your business is experiencing financial challenges, you could inadvertently violate a loan covenant, providing your lender with remedies you won’t want it to exercise. Proactively addressing difficulties while the economy is strong could save your business. Here’s how.

Two business professionals sitting down and discussing covenant loan compliance.

For the past 10 years or so, the U.S. economy has been flush with plenty of credit available for commercial loans at attractively low interest rates. But, as the economy approaches the end of one of the longest expansions in history, many expect the era of easy and inexpensive debt to go away. When that day comes, borrowers will face increased scrutiny from lenders and tougher enforcement of loan covenants. Will your company survive the next downturn?

If your company has long-term secured debt, it’s likely your loan has certain covenants that require you to do (or not do) certain things that range from timely reporting on business metrics to maintaining a minimum debt service coverage amount. Failure to abide by the covenants can trigger a default, even if you’ve never missed a payment. Here are a few signs to look out for and things you can do now to continue to secure financing for your business.

Are there warning signs I should be aware of?

Yes. Warning signs that could point to problems with your loan include:

  • Declining revenue
  • Declining cash balances
  • Increasing input costs
  • Excessive leverage
  • Decreasing business pipeline and backlog of orders
  • Loss of or danger of losing key customers
  • Supplier issues

If you’re noticing any of these signals in your business, chances are your lender is, too. But, unlike fine wine, financial and operational business challenges don’t improve with age. It’s better to proactively address these challenges that could trip a covenant sooner rather than later.

It’s better to take care of difficulties that could trip a covenant sooner rather than later.

What happens if I trip a loan covenant?

In a best-case scenario, the bank may agree to a simple amendment of the loan agreement with new covenants based on projected financial information. In more drastic situations, the bank may enter into a forbearance agreement, which could restrict new borrowing, CapEx, and owner distributions. Or it could go even further and require more collateral, refinancing with another bank, or initiate foreclosure/liquidation proceedings.

Frequently banks will require the retention of a restructuring consultant to act as an advisor to the company, and if necessary, develop a comprehensive restructuring plan. Therefore, if you’re in danger of tripping a loan covenant, we strongly recommend getting ahead and proactively hire a restructuring consultant now. Doing this gives you the advantage of choosing your own advisor, ensuring that he or she is focusing on your priorities, and it gives you critical lead time to prepare a restructuring plan. It can also give you credibility with the bank in early-stage negotiations.

What does a restructuring consultant do?

A restructuring advisor serves as a safety net between you and the lender. The advisor starts with a review of your company’s cash flow situation, which may be followed by preparing a restructuring plan and negotiations with the bank. The goal is to gain a quick understanding of where the company is at both financially and operationally, help the company perform better, get the bank comfortable, work out a refinance or other solution, and exit in the shortest time possible.

Doesn’t the expense just add to my financial problems?

What may feel like adding another burden to an already stressful situation can actually alleviate stress and help you in the long term. And often, when restructuring experts are brought in early, they can identify solutions that deliver cost savings sufficient to recoup the expense of their services. In our experience, the earlier an advisor is brought in, the less costly the process is over time.

What may feel like adding another burden to an already stressful situation can actually alleviate stress and help you in the end.

Where do I start?

We recommend starting with a financial health checkup.

A financial health checkup typically begins with a 13-week cash flow forecast to establish your company’s near-term cash position and determine its ability to manage cash and liquidity. If restructuring is required, the forecast will be used as a tool throughout the process to measure performance.

Once that’s complete, the next step is “covenant sensitivities testing.” It uses financial forecast models to determine how close you are to a loan default based on current and projected business conditions, what covenants you’re in danger of tripping, and when a default is likely to occur based on “what-if” scenarios.

Each health check is situation-dependent. In some cases, all that’s necessary is an analysis on cash flow that can be completed in a few weeks. If, however, issues are found that can trigger a covenant violation, the engagement can be extended to include a restructuring plan and assistance with lender negotiations.

I’ve tripped a covenant, now what?

Tripping a covenant is a technical default under a loan and security agreement, and is the trigger the bank needs to act. Lenders have a variety of remedies available, ranging from requiring the retention of a restructuring consultant to demanding immediate repayment of the loan in full.

For more information about the implications of tripping a covenant, listen to our on-demand webinar.

In conclusion

If your business is in trouble and you retain a restructuring consultant before you trip a covenant, you may be able to use today’s favorable economic conditions to refinance on better terms than you could after a default exists under the loan agreement. At Plante Moran, our restructuring advisors can help you assess your situation, structure a plan, help with lender negotiations, and provide assurance to the bank about your ability to “right the ship.” For more information, give us a call.