Managing Loan Covenants Amidst Pandemic Economic Impacts
Watch the webcast: Click the above video webcast by Capital Advisors Group EVP Stefan Spazek.
Some managers of emerging growth companies who took out loans prior to the pandemic may now be confronting the prospect of violating covenants written into their debt agreements. Debt covenants are financial and/or performance-based requirements that lenders put on borrowers to make sure loans are repaid on time. And because covenant testing is typically scheduled on a monthly, quarterly or semi-annual basis, June 30th may be a day of reckoning for those who have been affected by the pandemic over the prior quarter.
Stefan Spazek, EVP & Director of Debt Placement at Capital Advisors Group, has been counseling companies on venture debt transactions for the past 10 years. In the webcast above, he explains how borrowers and lenders typically try to work out solutions to problems with covenants before they escalate. And he provides helpful guidance to anyone at risk of triggering one or more covenants due to the economic stress from the extraordinary events of the past several months.
His first words of advice? Don’t panic. But do prepare for some serious conversations with your lenders.
“Ideally covenants are in place to prompt engagement or a conversation before more serious issues arise,” Spazek says. “If it appears the company is on track to trip a covenant, communication is key.” He recommends several steps that can lead to a productive outcome:
- First, if you think you may trip a covenant, start the conversation early. In fact, most covenants are there mainly as a conversation starter. Most lenders want to find a mutually acceptable remedy. Come up with an accurate forecast of when and how you will miss and prepare multiple downside projections depending on how the pandemic plays out. Paint a picture of what your business will look like when you come out the other side.
- Second, review the language of your covenants with your lender to be certain of the requirements and how they will be tested and on what frequency. If you expect a temporary disruption from the pandemic, there may be some flexibility. For instance, if they are tested on a rolling basis versus a static basis, you may be able to pull in positive numbers from pre-pandemic performance.
- Third, try to anticipate your lender’s needs. There are those who may move to immediately take control of the company and its cash. But others may be willing to restructure the terms, perhaps in return for additional fees or warrants. Lenders value their reputations, and few want to be seen as taking undue advantage of temporary adversity that no one could have predicted before the pandemic. Some may even be inclined to let things slide while staying in close contact with management.
Finally, if you are considering refinancing, think again. Granted, going to another lender in search of a new loan to get out from under your current restrictive covenants may be a viable strategy. After all, only your current lender may know that you tripped a covenant. However, the pandemic has made current borrowing terms much stricter than they likely were when you went to market for your current deal. You may find even more onerous covenants are now standard.
Furthermore, lenders always have questions when a company in a competitor’s loan portfolio tests the market, so expect greater-than-usual scrutiny. And there are always fees to consider when refinancing. Therefore, while refinancing is certainly an option, it may be best to try negotiating reasonable new terms with your current lender first.
Capital Advisors Group has been advising venture-backed and growth-stage companies on debt financing transactions since 2003. During that period, we have advised on billions of dollars of transactions, and reviewed thousands of term sheets for hundreds of companies. The pandemic has fostered economic dislocations that have created unprecedented challenges for borrowers and lenders. Stefan Spazek’s webcast provides insights on how to address these challenges by proactively engaging in a dialogue with lenders before potential problems get out of hand.
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