Drawing down a growth facility: what the covenants actually restrict

The term sheet was about the money. The facility agreement is about everything you must keep doing, and everything you may no longer do without asking, for as long as the money is outstanding.

Debt is cheaper than equity, and that is the trade

A founder funding expansion with a bank facility rather than a round keeps the shares. That is the attraction, and it is real. What is given up instead is a degree of operational freedom, written down in a document most founders read once, at speed, on the day of signing.

The facility agreement is not a loan note. It is a governance document with money attached. It says what you must tell the lender and when, what financial shape the business must stay in, what you may not do without asking, and what has to be true before each tranche is released. Those four things are the whole of it, and each of them constrains a decision you will want to make in the next two years.

None of this is a reason not to borrow. It is a reason to read the document as an operating plan rather than as paperwork.

Information undertakings: the calendar you have just agreed to

The first section that bites is the least dramatic. Information undertakings set out what goes to the lender and by when: annual audited accounts within a stated number of months, management accounts monthly or quarterly within a stated number of days, an annual budget before the start of each financial year, and a compliance certificate confirming the covenant position, usually signed by a director.

Two things go wrong here, and neither involves the business trading badly.

The first is capacity. A business that has been producing management accounts when it gets round to it has now promised to produce them to a deadline, in a specified format, indefinitely. If the finance function cannot do that, the breach arrives before the first covenant test does.

The second is the compliance certificate. It is a positive statement, made by a named person, that the covenants are met and no default has occurred. Signing it without having actually run the calculation is how a technical breach becomes a misstatement, and it is the point at which a lender's tone changes.

Financial covenants: the numbers that decide who is in control

Financial covenants convert the lender's credit assumptions into tested obligations. The usual four are leverage, interest cover, debt service cover and, on capital-intensive plans, a limit on capital expenditure.

The headline ratio matters far less than three things underneath it.

The definitions. EBITDA in a facility agreement is whatever the agreement says it is. Whether you may add back exceptional items, pre-opening costs for new sites, share-based payments or the losses of an acquisition in its first year is a drafting question, and it is the single most valuable thing to negotiate. A covenant set at a comfortable level on a punitive definition is tighter than a demanding covenant on a fair one.

The test dates and periods. Covenants tested quarterly on a rolling twelve-month basis behave very differently from covenants tested on a year-to-date basis, particularly in a seasonal business. If your trade is concentrated in two quarters, insist the testing regime reflects that. It is far harder to change afterwards.

The headroom against your own plan, not the plan you pitched. Model the covenant against a downside case, not the case that won the credit committee. The point of headroom is to survive a bad quarter without a conversation.

Expansion has a specific trap. Opening sites, hiring ahead of revenue and buying equipment all depress EBITDA and increase debt in exactly the period the facility exists to fund. If the covenant definitions do not carve out the cost of the expansion the lender is financing, the plan breaches the covenant by working as intended.

The negative covenants: what you can no longer do alone

This is the section founders are most surprised by, because it is written as a series of prohibitions with consents carved back out of them.

Disposals. Selling assets outside the ordinary course of business — a site, a subsidiary, a piece of intellectual property, a division — will need consent above a threshold. Founders discover this when a good opportunistic sale appears and the answer is not theirs alone.

Further borrowing and security. A negative pledge stops you granting security to anyone else, and a limit on financial indebtedness catches more than a second bank loan. Invoice finance, asset finance on vehicles or equipment, and some supplier credit arrangements can all count. A business that quietly takes asset finance for a delivery fleet may breach a facility it is not otherwise troubling.

Acquisitions and joint ventures. Usually prohibited above a modest permitted-acquisition basket, with conditions on how any acquisition must be funded and integrated.

Distributions. Dividends, and often director loan repayments, are restricted while the facility is outstanding, sometimes entirely and sometimes only while a covenant is close to breach. Founders who have historically taken remuneration partly by dividend need this checked before signature, not afterwards.

Change of control. Almost always mandatory prepayment rather than a prohibition — but the effect is the same. A trade sale, or in some drafting a large secondary, triggers repayment of the facility in full. That has to be modelled into any exit, because the buyer will price it.

Conditions precedent: why the money is not actually there yet

Signing a facility does not mean the money is available. Each drawdown, and often the first drawdown in particular, is conditional on delivering a list of documents and satisfying a list of statements.

Typical conditions include board and shareholder resolutions in the lender's form, constitutional documents, security documents completed and, where they are registrable, delivered for registration, evidence of insurances, legal opinions where a group has overseas entities, and confirmation that the repeating representations remain true and no default has occurred.

For expansion this is where timing goes wrong. A founder plans an opening around a drawdown date, and the drawdown slips because a subsidiary's security document is unsigned, a landlord's consent has not arrived, or a group company's registers are not in order. The building programme does not slip with it, and the funding gap becomes the founder's problem.

Two practical rules follow. Work backwards from the drawdown date rather than forwards from signing. And do the corporate housekeeping — registers, filings, minute books, share certificates — before the facility, not during it, because every hour spent reconstructing a register is an hour the drawdown is not happening.

Security, and one deadline that does not move

Where the facility is secured, charges granted by a UK company must be delivered to Companies House within 21 days beginning with the day after the charge is created. Miss it and the security is void against a liquidator, an administrator and the company's other creditors. The court can extend the period in some circumstances, but that is a remedy, not a plan.

This is normally the lender's solicitors' job and normally happens correctly. It is worth knowing about anyway, because if the security fails the lender will look for a remedy, and the remedy will be found somewhere in your documents.

Where a specialist is needed

Where a facility is secured, the security package and its registration are drawn and perfected by the lender's solicitors, with a solicitor acting for the company; Dinmore Bell instructs and manages that side and holds the budget. Legal opinions on overseas group entities go to local counsel in the relevant jurisdiction.

The tax treatment of interest deductibility, of any restructuring done to accommodate the facility, and of changes to how founders take remuneration when distributions are restricted, is your accountant's or tax adviser's. And if a facility moves into enforcement, the conduct of proceedings goes to a litigator we instruct.

What Dinmore Bell does with it

Two things, and they are separate.

Before signature, we negotiate the terms that actually constrain the plan: the EBITDA definition and its add-backs, the test dates and the treatment of expansion costs, the permitted disposals and permitted indebtedness baskets, the distribution position, and the conditions precedent list against a realistic timetable.

After signature, we run it. The reporting deadlines and covenant test dates go into the same register as every other contractual date in the business, with someone whose job it is to act on them rather than report them. Consents are requested before they are needed rather than after. And when a covenant is going to be tight, the conversation with the lender happens early, from a position of information, which is the only version of that conversation worth having.

Dinmore Bell provides an outsourced General Counsel function for founder-led businesses, owning work of this kind end to end rather than advising on it and handing it back.