Module IV· Debt RatiosAdvanced
Question
What are 'equity cure rights' and how do they affect covenant tests?
Answer
Mechanics
An equity cure is the sponsor's right to "cure" an impending covenant breach by injecting additional equity. Typically capped at 2-4 cures over the life of the loan.
Deep diveShow more details
Example
| Item | Value |
|---|---|
| Senior Debt / EBITDA current | 5.8x |
| Covenant limit | 5.5x |
| Impending breach | yes, 0.3x over the limit |
| Sponsor equity cure | $50m new injection |
| Treatment | EBITDA increased pro forma OR debt reduced |
Two cure mechanisms
- EBITDA adjustment: the equity injection is counted virtually as additional EBITDA (e.g. 50 / 1 = $50m EBITDA boost). Senior Debt / EBITDA is recalculated
- Debt reduction: cure equity is used for repayment — a direct effect on the numerator
Comparison of the mechanisms
| Aspect | EBITDA adjustment | Debt reduction |
|---|---|---|
| Sponsor-friendly | very | less |
| Lender-friendly | less | very |
| Long-term effect | trigger quarter only | permanently lower debt |
| Middle-market standard | EBITDA adjustment more common | -- |
Consequence
The equity cure is the sponsor's shield against cyclical downturns. But: cure frequency is limited (typically max 2 in a row, max 4 total) — for structural problems that is not enough.
Pitch tip
Question: "Why does a lender accept an equity cure?"
Answer: "Win-win: the lender gets a skin-in-the-game signal from the sponsor (commitment), the sponsor gets a cushion against short-term weakness. But cure-equity volume is usually capped at 25-35% of the original EBITDA shortfall"