Why this matters

Loan covenants are the levers lenders use to control credit risk. For a startup, a badly shaped covenant package can throttle hiring, R&D, acquisitions, or follow-on fundraising. Conversely, well-negotiated covenants give lenders assurance while preserving the startup’s ability to execute its growth plan. In my practice working with over 500 clients, I’ve repeatedly seen covenant changes unlock funded growth or, when ignored, force painful restructurings.

Types of covenants startups will see

  • Affirmative (positive) covenants: obligations such as delivering monthly financials, maintaining insurance, or preserving intellectual property. These are generally low-friction but can impose recurring compliance costs.
  • Negative covenants: prohibitions on actions like incurring additional debt, paying dividends, selling key assets, or changing the business model without lender consent.
  • Financial covenants (ratios and thresholds): minimum cash, maximum leverage (debt/EBITDA or debt/equity), minimum liquidity, fixed-charge coverage ratio. These are the most common triggers of technical default.
  • Reporting covenants: timing and detail of financial and operational reporting — monthly vs. quarterly, audited vs. unaudited, KPI schedules.

Authoritative context: lenders and regulators view covenants as standard underwriting tools. See Consumer Financial Protection Bureau guidance on fair lending practices and disclosures as background to lender behavior CFPB. Small business lending resources at the U.S. Small Business Administration explain borrower protections and obligations SBA.

Negotiation playbook — step-by-step

  1. Prepare the covenant model
  • Map every covenant the lender proposes. Translate each into an Excel scenario that shows how changes in revenue, burn rate, fundraising delays, or capex affect covenant compliance over 12–24 months.
  • Identify the most likely covenant breaches under realistic downside scenarios.
  1. Prioritize covenants to contest
  • Rank covenants by business impact: financial ratios usually matter most, then negative covenants that limit strategic moves, then reporting/administrative asks.
  1. Build a narrative and evidence package
  • Provide three things lenders value: (a) clear historical metrics, (b) realistic forecasts with sensitivities, (c) mitigants (cash reserves, committed investors, contracts). In my practice these documents have moved lenders to relax numeric thresholds or add cure periods.
  1. Propose concrete alternatives
  • Instead of a hard maximum debt/equity cap, propose a sliding scale tied to revenue growth or a covenant step-down after certain milestones.
  • Replace absolute EBITDA thresholds with trailing-12-month (TTM) measures or add an adjustment for non-cash expenses (e.g., stock comp) if justified.
  • Ask for exceptions/baskets: limited carve-outs for additional fundraising, acquisitions under $X, or capital expenditures up to $Y.
  1. Negotiate remedies and cure mechanics
  • Seek cure periods (30–90 days) and waiver mechanics before an event of default accelerates the loan.
  • Limit cross-default language to material agreements only, and carve out ordinary-course leases or supplier contracts.
  1. Document negotiated changes
  • Ensure every concession is captured in an amendment or side letter. Avoid handshake agreements.

Practical negotiation levers (what you can ask for)

  • Higher thresholds or lower ratio requirements
  • Measurement frequency changes (quarterly vs. monthly) to reduce administrative burden
  • Grace and cure periods for temporary covenant misses
  • Baskets and exceptions for ordinary-course activities, acquisitions, or follow-on capital
  • Carve-outs for equity raises and investor protections
  • Interest rate step-up caps and maximum default interest

Sample language ideas you can suggest (examples, not legal advice)

  • Liquidity covenant: “Borrower shall maintain unrestricted cash and cash equivalents of not less than $X at the end of each fiscal quarter, measured on a trailing 30-day average.” (averaging reduces one-off timing issues)
  • Debt incurrence carve-out: “Notwithstanding the foregoing, Borrower may incur additional Indebtedness in the ordinary course of business not to exceed $Y in aggregate outstanding principal at any time.” (creates a small operational runway)
  • Cure clause: “If Borrower breaches Section [X], Borrower shall have 60 days to cure such breach; if cured within such period, no Event of Default shall have occurred.” (reduces acceleration risk)

Red flags that should trigger pushback

  • Unlimited cross-defaults to immaterial contracts
  • Quarterly liquidity tests with immediate default and no cure period
  • Broad change-of-control definitions that allow lender discretion to call the loan on minor ownership changes
  • Reporting demands that require audited financials monthly or onerous proprietary KPIs that reveal confidential strategy

How negotiation differs by lender type

  • Banks: Generally conservative; open to sensible financial covenants. They favor clear numeric ratios and documentation. Use historical financials and audits to support requests.
  • Venture debt providers: More flexible on covenants but will focus on cash runway and VC support. They can be persuaded with committed equity backstops or covenant step-downs tied to fundraising milestones. See our deeper look at venture debt expectations Loan Covenants in Venture Debt: What Founders Should Expect.
  • Alternative/non-bank lenders: Often stricter on pricing and covenants; expect less room for negotiation unless you bring leverage or multiple term sheets.

Monitoring and operationalizing covenant compliance

  • Assign a single owner (CFO or controller) for covenant reporting.
  • Create a covenant calendar with measurement dates, required filings, and a near-miss alert system (e.g., if any metric falls within 10% of the covenant threshold).
  • Integrate covenant scenarios into your monthly cash-forecasting model.

Post-signing: modifying covenants

  • Covenants can be amended. Your best leverage is improved performance, upcoming positive milestones (new contracts, fundraising), or competing offers. Document amendments formally; use side letters only for temporary concessions and amendments for material changes.
  • If facing an imminent breach, communicate early with lenders and present a remediation plan — lenders prefer proactive partners versus surprise defaults. For more on triggers and next steps, review our guide What Triggers a Loan Covenant Breach and What Happens Next.

Negotiation checklist (quick)

  • Model every covenant under 3 downside scenarios
  • Identify top 3 covenants to change and prepare alternatives
  • Ask for averaging, trailing measures, or cure periods
  • Request baskets/carve-outs for fundraising, acquisitions, and capex
  • Limit cross-defaults and tighten the definition of “material”
  • Insist on written amendments, not oral promises

When to walk away

  • If covenants are so restrictive they make achieving your business plan impossible
  • If cure mechanics are absent and default equals immediate acceleration
  • If the lender demands full personal guarantees or unlimited recourse inconsistent with your stage and risk profile

Examples from practice

  • Tech SaaS: We replaced a monthly liquidity test with a trailing-30-day average and added a 60-day cure. Outcome: preserved hiring runway and avoided a technical default during a seasonal revenue dip.
  • Retail startup: Negotiated a limited debt-incurrence basket tied to new-store cash flows, allowing incremental expansion without waiver costs.

Further reading and authoritative sources

Professional disclaimer: This article is educational and based on general practice experience; it does not constitute legal or financial advice. Consult a qualified attorney and financial advisor before finalizing or amending loan agreements.

Author note: In my 15 years advising startup founders, I’ve found that preparation, clear metrics, and early lender communication are the most effective levers for improving covenant packages. Thoughtful covenant design protects both the lender’s risk and the startup’s ability to grow.