Managing Debt Obligations and Ensuring Compliance With Covenants

Having debt on your balance sheet underscores the importance of discipline in your financial management. Now, you not only have to run the business but also continuously ensure you’re meeting the debt obligations and not tripping any wires in the loan agreement. Here’s how to stay on top of it:

• Mark your calendars for payments: Avoid missing a payment by setting automatic payments or at least, a reminder to pay. This could very likely save you money! A late payment may incur incremental interest or some other penalty.
• Internal financial monitoring: Check covenant metrics more frequently than required. If you’re near a threshold, take corrective action early. Get in front of it. Remember, the lender, at the end of the day, wants to grow with you; closing down a business is extremely labor intensive and likely results in a loss of capital.
• Build in buffers: Don’t operate at the edge of a covenant. Communicate potential breaches to the lender before they happen.
• Refinance or adjust if needed: If conditions improve or you overborrow, consider refinancing or partial repayment, as long as the loan agreement allows it. If you need a little (not a ton) more flexibility, there’s no harm in going to the lender to ask for it, and they’ll likely appreciate the transparent communication. However, make sure to do this from a position of strength, or else you may pay for it.
• Multiple debt instruments: If you add another permissible loan, make sure that there are no terms in the original loan paperwork that conflict with the new debt. You may need to figure out an intercreditor agreement (“ICA”) so that all of the debt in your capital stack works together.
• Stay organized: Keep a digital folder of loan documents, waivers, and amendments for quick reference. Reread these in detail if you’re considering modifying your existing agreement or going out to the market for new financing.

Overall, ensuring compliance is about instilling rigor in how you run the financial side of the business. Many founders actually find that having a debt facility makes them run a tighter ship and that’s not a bad thing. It can lead to better habits (regular financial reporting and budget discipline) which VCs and stakeholders will appreciate, too.

Avoiding common pitfalls and challenges after securing debt

With your newfound capital management responsibilities, you’ll want to keep an eye on the following risks that can come up with new debt on your balance sheet.

• Overextension and spending creep: Scaling expenses or headcount without matching revenue can worsen your financial position and create concern about your debt. Grow thoughtfully.
• Ignoring early warning signs: Address issues early, adjust quickly, and proactively communicate risks to lenders. To keep a good relationship with your lender, it can make sense to inform them if a covenant might be at risk.
• Not having a backup plan: Always have contingency plans. Could you extend the loan an extra year or take a bridge round from investors? If your financial plans don’t pan out, you’ll want to have options for your debt obligations.
• Covenant triggers and technical defaults: Accidentally breaching loan terms (e.g., adding debt or paying bonuses) can cause defaults. Always verify key financial moves; if unsure, consult your lender.
• Being adversarial: If you treat the lender as a nuisance or transactionally, you will pay for it. Always assume that a lender is more knowledgeable than you when it comes to conflict, specifically over the capital you raised from them – after all, they are only focused on this day after day across many deals while you are trying to run an entire business. Treat a lender relationship with respect, seriousness, and transparency, just as you would any other important business relationship.

The relationship you have with your lender ultimately boils down to your discipline, transparency, and adaptability. If you sense a potential issue, address it early. If you’re unsure about something, ask for advice from mentors, your board, or even the lender.