What is an equity cure right in a loan agreement?

How a cure works, step by step

• The test fails. The quarter's compliance certificate shows a financial covenant missed: leverage above the maximum, or coverage below the minimum.
• The borrower gives notice that it intends to cure. Most agreements require notice by the date the certificate is due.
• A standstill applies. While the cure window is open, the lender agrees not to accelerate the loan or exercise remedies for that breach. It usually does not agree to fund new revolver draws until the cure is in.
• The cash goes in within the window, as common equity or as debt fully subordinated on terms the lender accepts. It has to be new money from the owners, not a draw on the company's own line.
• The covenant is recalculated with the cure amount counted as the agreement specifies. If the recalculated figure passes, the breach is treated as never having happened.

Cure rights are standard in sponsor-backed private credit loans and far less common in bank loans to owner-operated companies. Without one, a miss is handled by a waiver or an amendment, on whatever terms the lender sets at the time; see what to do when you breach a loan covenant.

EBITDA cure or debt cure: why it matters

The agreement decides whether the cure cash is added to EBITDA for the failed period, or treated as repaying debt. On a leverage test the difference in how much cash it takes is large.

A company has funded debt of 6,000 and LTM EBITDA of 1,800, for leverage of 3.33. Its covenant maximum is 3.0.

An EBITDA cure costs a third of the cash in this example, because each 1 of added EBITDA is worth three of debt at that covenant level. That is exactly why lenders limit EBITDA cures so carefully: cash that never earned anything is being counted as earnings, and it stays in the twelve-month window for four tests. A debt cure costs more but leaves the company genuinely less indebted.

On a fixed charge coverage test, a debt cure barely works: repaying principal early does little to the fixed charges the test measures. That is why coverage covenants are almost always cured through EBITDA, if they can be cured at all. Suppose, for this example, fixed charges of 1,000 and a coverage minimum set at 1.25x. Cash flow of 1,100 misses the test; a cure of 150, counted as EBITDA, brings it to 1,250 and passes.

Read how the cure counts before you read how often you can use it. It sets the price of every cure.

The usual limits

Lenders accept cure rights because they want an owner who will put in money when the business stumbles. They limit them so that an owner cannot use cash to hide a business that has stopped performing. The common limits, each set in the agreement:

• Frequency. No cures in consecutive quarters, a cap on how many in any four-quarter period, and a cap over the life of the loan.
• Amount. No more than the amount needed to pass the test. An over-cure, putting in extra so the next quarters look comfortable, is usually disallowed or ignored.
• Purpose. The cure counts only for the financial covenants. It does not count toward the pricing grid, toward permitted distributions or baskets, or toward any other test that uses EBITDA.
• No double benefit. If the agreement requires the cure cash to be used to prepay the loan, the prepayment is ignored for the quarter being cured, so the same money is not counted as both EBITDA and debt reduction.
• Which covenants. Usually leverage and coverage tests. A minimum liquidity or excess availability test is often excluded, because putting cash in the bank already satisfies it.

What a cure does not fix

A cure deals with one missed test. It does not deal with why the test was missed. A lender watching a borrower cure twice in a year will read it as a sign the covenants no longer fit the business, and the next conversation will be about an amendment, a paydown or a different lender. The cure also does not cure other defaults: a late compliance certificate, a missed payment or a breach of a negative covenant each stands as an event of default on its own.

For an owner-operated company, the source of the cure is personal. The owner writing the check is often the same person who has personally guaranteed the loan, so the question is whether to put cash in now or face the guarantee later. For an independent sponsor without a committed fund, the question is whether its investors will fund a cure at all, and lenders ask it at underwriting.

Negotiating it before you need it

Cure rights are negotiated in the term sheet, when the borrower has leverage, not after a miss, when it has none. The points worth pressing: EBITDA treatment rather than debt paydown, a realistic window to raise the cash, cures available from the first test date, and a lifetime cap that matches the length of the loan. Pair it with honest covenant headroom, so the cure is a backstop rather than a plan. For how cures fit into a full credit agreement negotiation, see equity cures in a credit agreement.

Transparent's financing model tests every covenant quarter by quarter against a downside case, and shows how large a cure each quarter would need, so the owners know the size of the commitment before they sign.