Covenants are contractual commitments in loan agreements by which a borrower undertakes to maintain certain financial ratios or operational constraints throughout the life of the loan. Financial covenants (leverage ratio, interest coverage, minimum equity) are the most common in leveraged finance. Information covenants (periodic financial reporting) and action covenants (restrictions on acquisitions, dividends, additional debt) complement them. In financial due diligence, covenant headroom analysis is essential: a breach triggers immediate loan acceleration, threatening the company's financial stability and potentially the acquisition itself.

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Example: an LBO loan of CHF 15.0 million includes a net debt/EBITDA leverage covenant of ≤ 4.0x. At the time of due diligence, the ratio stands at 3.4x — leaving CHF 1.8 million of EBITDA headroom before breach. The post-acquisition business plan projects a ratio of 2.9x at year-end N+1: headroom is sufficient unless EBITDA underperforms by more than 15% versus projections.

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Hectelion analyses covenant headroom and stress-tests it against downside scenarios in every leveraged transaction due diligence.