Module IV· Debt RatiosAdvanced
Question
What is an 'EBITDA cushion test' compared with maintenance covenants?
Answer
Mechanics
An EBITDA cushion test = a contractual test that checks a minimum-EBITDA threshold (instead of a ratio). A supplement or alternative to leverage-ratio tests.
Deep diveShow more details
Comparison
| Test type | Example | Trigger |
|---|---|---|
| Senior leverage ratio (maintenance) | Senior Debt / EBITDA < 5.0x | EBITDA drop OR debt increase |
| EBITDA cushion (maintenance) | EBITDA > $30m | EBITDA drop only |
| Interest coverage (maintenance) | EBITDA / Cash Interest > 2.5x | coverage drop |
Example
| Item | Value |
|---|---|
| Initial EBITDA at closing | $50m |
| EBITDA cushion floor (contractual) | $30m (60% of initial) |
| Current EBITDA | $35m |
| Cushion status | ✓ still above floor |
Consequence
The cushion test is absolute protection for the lender — independent of debt modifications. It is often used when:
- the sponsor de-levers aggressively (senior debt falls faster than the EBITDA decline)
- the lender wants to guarantee minimum coupon coverage
- the sector has volatile EBITDA (consumer goods, construction, automotive)
Common pitfalls
- Cushion floor set too low → no real protective effect
- Cushion based on LTM EBITDA → ratio effect with a quarterly lag
Pitch tip
Question: "When is a cushion test more useful than a leverage ratio?"
Answer: "In volatile sectors — a leverage ratio can be 'cured' by aggressive de-leveraging, while an EBITDA floor protects directly. In the middle market it is fairly unusual, but in cyclical sectors it is often combined"