Covenant Review in Leveraged Buyouts: What to Read Before You Sign
Covenant packages in leveraged buyouts are easy to underestimate and expensive to misread. This episode of VDR.ai cuts through the complexity of credit agreement review, explaining why a surface-level read of headline ratios leaves buyers exposed — and what a rigorous, model-integrated covenant analysis actually looks like. If you're approaching signing on an LBO and haven't stress-tested the debt terms against your operating plan, this is required listening.
The episode walks through the three layers of covenant review that every deal team should work through, and why each demands a different analytical lens:
- Maintenance covenants: These ratios — typically leverage and interest coverage — are tested on a schedule regardless of business activity. Understanding them means tracing every defined term back through the agreement: what's in EBITDA, whether add-backs are capped, and what operating cushion actually separates normal performance from a default.
- The definition problem: Operative restrictions, definitions, and carve-outs rarely appear in the same place. Reading a headline ratio in isolation — without mapping how "net debt," "consolidated group," and cure mechanisms are defined — gives a dangerously incomplete picture.
- Incurrence covenants and post-close strategy: Unlike maintenance tests, incurrence covenants are only triggered when the borrower acts — taking on debt, making acquisitions, paying dividends. But they directly govern your value creation plan. A tuck-in acquisition in year two may require lender consent if leverage thresholds aren't met by then.
- Restricted payments: The most commonly skimmed layer. This covenant controls whether cash generated by the business can actually flow back up the capital structure. Sponsor-owned businesses with tight maintenance covenants and no builder basket may be legally unable to distribute cash before exit — a material issue that warrants explicit attention.
- Structuring the counsel hand-off: Outside counsel reports on what the document says; they rarely flag how it conflicts with your model or hundred-day plan unless you provide that context. A productive review means sharing operating assumptions and post-close priorities upfront, then asking counsel to identify where the covenant package creates friction. Cross-document reconciliation across the credit agreement, financial model, and operating plan is where the most actionable gaps tend to surface.
- Legacy facilities in carve-outs and refinancings: When existing debt travels with the asset, those terms don't automatically reset. Pre-existing covenants can be materially more restrictive than a fresh syndication — and assuming otherwise is a structural error.
Teams running structured diligence processes can use the AI risk register to surface and track covenant-related exposure across documents, and diligence Q&A to coordinate follow-up with counsel and lenders in a single auditable thread. For more on building the debt package before you get to covenant review, see the companion episode Lender Package Prep: How to Build a Debt Package That Gets to Credit Fast.
