Covenants are an essential part of the loan agreement obligations in LBO transactions. Financial covenants in particular play an important role in credit agreement clauses.

The financial crisis and the accompanying credit crunch led to a slump in LBO-based corporate takeovers. Since the collapse of Lehman Brothers, the general contractual covenants and financial covenants have also become much stricter.

This is the conclusion of a survey conducted by the KfW Chair of Entrepreneurial Finance at the Technical University of Munich among European lead arrangers and private equity firms on the importance and design of financial covenants in LBO transactions before and after the Lehman collapse. For the study, a standardized questionnaire was sent to 307 addressees, to which 25 lead arrangers and private equity firms of various sizes and regional focus responded.

Basic information on covenants

Covenants are ancillary contractual obligations with which the borrower is bound as part of the loan agreement. Two types of covenants can be distinguished: Non-financial covenants and financial covenants. Non-financial covenants are primarily aimed at ensuring that the borrower cannot take any actions that reduce the value of the loan to the creditor. They include, for example, assurances by the borrower to obtain the creditor's consent for certain profit distributions or planned investment projects. This means that the operational use of liquidity surpluses can be better controlled. The lender's required declaration of consent to restructuring transactions protects it against an unwanted change in the capital structure. Other objectives of non-financial covenants are to improve the lender's information position about the borrower or to allow the lender regular insight into company data. Non-financial covenants also include obligations such as operating in compliance with the law or environmental requirements.