You are reading the financial covenants section of your term sheet. One of the conditions is the Debt-to-equity ratio covenant. Here is what it measures, why the bank includes it, and what to check before you sign.
What the bank is measuring
A debt-to-equity covenant limits total debt to a multiple of shareholder equity. It ensures the company maintains a minimum equity cushion relative to its borrowing.
What this means: Equity reductions (e.g., losses, dividend payments, share buybacks) can push you closer to breach. Retained earnings directly affect your headroom.
What to check
Equity definition: does it include subordinated shareholder loans?
One-off losses (write-downs, restructuring costs) can trigger breach even in healthy businesses
Dividend restrictions often accompany this covenant
How to negotiate
Most covenant terms are negotiable at the term sheet stage, before the legal documentation is drawn up. With the Debt-to-equity ratio covenant, focus on the definition, the threshold, the testing frequency, and the cure period. Ask your relationship manager what flexibility exists, and have your accountant confirm the level is one your business can hold comfortably. Read every line.
What to do next
The fastest way to see whether a Debt-to-equity ratio covenant — and every other condition — is in your term sheet is to let Credia read it for you. Upload the PDF and you get every covenant identified and explained, in plain language, in under two minutes.
Analyse your term sheetFrequently asked questions
What is a Debt-to-equity ratio covenant?
A debt-to-equity covenant limits total debt to a multiple of shareholder equity. It ensures the company maintains a minimum equity cushion relative to its borrowing.
What happens if you breach a Debt-to-equity ratio covenant?
Equity reductions (e.g., losses, dividend payments, share buybacks) can push you closer to breach. Retained earnings directly affect your headroom.
Can you negotiate a Debt-to-equity ratio covenant?
Most covenant terms are negotiable at the term sheet stage, before the legal documentation is drawn up. With the Debt-to-equity ratio covenant, focus on the definition, the threshold, the testing frequency, and the cure period. Ask your relationship manager what flexibility exists, and have your accountant confirm the level is one your business can hold comfortably. Read every line.