Term · Risks & Red Flags
Covenant Breach
In briefA covenant breach occurs when a company violates contractual loan conditions on leverage, interest coverage, or equity ratio. For small-caps this can quickly lead to renegotiations, higher interest rates, or a restructuring.
Definition
A covenant breach is the violation of contractual loan conditions, such as on leverage, interest coverage, or equity ratio.
How it is calculated
Formula. No standard formula; relevant covenants can be Net Debt/EBITDA, interest coverage, or minimum liquidity.
Why it matters for small caps
In the small-cap space, a covenant breach can quickly lead to renegotiations, higher interest rates, or restructuring.
Common misreadings
- Covenant breaches are often only seen as a problem once loans are called due, even though waiver costs and loss of control already loom.
In the process
Frequently asked
What is a covenant breach?
It is the breach of a ratio or condition agreed in the loan contract. Often affected are limits on leverage, interest coverage, or minimum liquidity.
What are the consequences of a covenant breach?
Lenders can adjust terms, demand collateral, or grant a waiver for a fee. This shifts costs and control to the company's disadvantage.
Why is the danger of a covenant breach often underestimated?
Many only notice it once loans are called due. In fact, waiver costs and a loss of bargaining power loom even earlier.
Related terms
Sources
Primary
IFRS Foundation – IFRS 7 Financial Instruments: Disclosures
https://www.ifrs.org/issued-standards/list-of-standards/ifrs-7-financial-instruments-disclosures/
https://www.ifrs.org/issued-standards/list-of-standards/ifrs-7-financial-instruments-disclosures/
Methodology
Bundesministerium der Justiz – Handelsgesetzbuch (HGB)
https://www.gesetze-im-internet.de/hgb/
https://www.gesetze-im-internet.de/hgb/
Education only, not investment advice. Ranges and thresholds are didactic orientation values, not an official standard.