The same breach costs the sponsor 5.50 times more when the agreement says the cure must repay debt.
An equity cure needs the gap between actual and permitted EBITDA if the cash is deemed EBITDA, and the gap between actual and permitted net debt if it must prepay the loan. On an illustrative borrower at 5.90 times against a 5.50 times leverage covenant, that is 2.91 million as deemed EBITDA against 16.00 million as a prepayment. The second is always the first multiplied by the covenant level, here 5.50 times.
Worked in full in How to Read a Credit Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A sponsor-owned borrower reports its compliance certificate for the quarter. Last-twelve-month Consolidated EBITDA, as the agreement defines it, has fallen to 40.0 million, and net debt stands at 236.0 million. The maintenance covenant caps net leverage at 5.50 times. The agreement gives the sponsor an equity cure right: fresh equity, contributed within the cure period, can be applied to the test. Which way it can be applied is a drafting question, and it decides the cheque.
| Input | Value |
|---|---|
| Consolidated EBITDA, last twelve months | 40.0 |
| Net debt | 236.0 |
| Maximum net leverage | 5.50x |
| Net leverage tested | 5.90x |
Cure as deemed EBITDA: X = net debt / covenant − EBITDA
X = 236.0 / 5.50 − 40.0 = 42.91 − 40.0 = 2.91
Cure as prepayment of debt: Y = net debt − covenant × EBITDA
Y = 236.0 − 5.50 × 40.0 = 236.0 − 220.0 = 16.00
In Excel, with EBITDA in B2, net debt in B3 and the covenant in B4: =B3/B4-B2 and =B3-B4*B2.
Deemed EBITDA works on the denominator, so each euro of equity is worth 5.50 euros of debt capacity. A prepayment works on the numerator, euro for euro. Divide the two formulas and the ratio is exactly the covenant level: Y = C × X. That holds for any borrower and any size of breach. A sponsor curing a 5.50 times covenant by prepayment pays 5.50 times what it would pay under deemed EBITDA drafting, for an identical compliance outcome.
Put another way, the EBITDA cure fills a 7.3 per cent shortfall in earnings. The prepayment cure has to remove the whole 0.40 turn of excess leverage at the debt level: 0.40 times 40.0 of EBITDA is the same 16.00.
A bad patch rarely lasts one quarter. Suppose the next test date shows EBITDA of 38.0 and net debt of 234.0, the cure cash disregarded. Unadjusted leverage is now 6.16 times. The two drafting routes carry the first cure forward differently: deemed EBITDA stays in the last-twelve-month figure for the following three test dates, and a prepayment stays paid.
| Step | Deemed EBITDA route | Prepayment route |
|---|---|---|
| EBITDA tested | 40.91 | 38.0 |
| Net debt tested | 234.0 | 218.0 |
| Leverage before a second cure | 5.72x | 5.74x |
| Second cure needed | 1.64 | 9.00 |
| Equity over two quarters | 4.55 | 25.00 |
The prepayment does keep working: 16.00 of debt repaid lowers the second quarter's net debt to 218.0. But deemed EBITDA keeps working too, because the 2.91 sits in the trailing figure. Both routes breach again, and the second cure is again in the ratio of the covenant: 9.00 against 1.64. Over two quarters the sponsor writes 25.00 million under prepayment drafting and 4.55 under deemed EBITDA drafting, a difference of 20.45 million settled by one clause.
Two consecutive cures already use up a typical limit of two cures in any four consecutive quarters. A third bad quarter cannot be cured at any price, so the cure right does not cover the case it was negotiated for. Count the breach quarters in the downside case against the cure limit before the term sheet is signed.
Hold the breach constant at 0.40 turns above the covenant and move the covenant level. The prepayment needed does not change: it is always 0.40 times EBITDA. The EBITDA cure shrinks as the covenant rises, because each euro of deemed EBITDA buys more debt capacity at a higher multiple.
| Covenant | Net debt | Leverage | EBITDA cure | Prepayment cure | Ratio |
|---|---|---|---|---|---|
| Tight, 4.00x | 176.0 | 4.40x | 4.00 | 16.00 | 4.00x |
| Mid-market, 5.00x | 216.0 | 5.40x | 3.20 | 16.00 | 5.00x |
| This case, 5.50x | 236.0 | 5.90x | 2.91 | 16.00 | 5.50x |
| Covenant-loose, 6.50x | 276.0 | 6.90x | 2.46 | 16.00 | 6.50x |
This is why lenders on higher-leverage deals push for prepayment drafting, or for a cap on the amount that can be deemed EBITDA. The looser the covenant, the cheaper a deemed EBITDA cure becomes relative to the debt it supports.
A cure contributed as deemed EBITDA also lands on the balance sheet as cash, and cash reduces net debt. If a borrower counts it both ways, the cure needed falls to 2.46: solve (236.0 − X) / (40.0 + X) = 5.50 and X = 16.00 / 6.50. Most agreements forbid this explicitly, through a no-netting provision for the cure amount in the quarter it is counted. A model that nets the cash shows a smaller cure than the agreement requires, and a sponsor that funds 2.46 instead of 2.91 has not cured. Read the cure clause for three things before computing anything: the form (EBITDA, debt or the borrower's choice), the netting rule, and the limits on number and amount.
Size the cure from the definition, not from the headline ratio: 2.91 as deemed EBITDA, 16.00 as a prepayment, and the ratio between them is the covenant level. The book's Kestrel facility makes the same comparison on a real breach, 3.59 million against 19.74 million, a factor of 5.5; the model is in the free workbook for this case. For how far add-backs move the EBITDA the cure is measured against, see what an add-back bridge is worth in leverage turns, and for the real estate version of the same arithmetic, the cure ratio in a coverage covenant.
Usually not in the quarter it is counted as EBITDA: most credit agreements include a no-netting rule for the cure amount. If the cash were netted as well, the illustrative cure would fall from 2.91 to 2.46 million, so a model that nets it understates the cure the agreement actually requires.
A common formulation is no more than two cures in any four consecutive quarters and four or five over the life of the facility. In the illustrative case two consecutive cures, 2.91 and 1.64 million, exhaust a two-in-four limit, leaving a third breach quarter uncurable whatever the sponsor offers.
Because a prepayment reduces the debt at risk instead of inflating the earnings measure. In the illustrative facility the prepayment route takes 16.00 million of debt out against 2.91 million of deemed EBITDA, and the gap grows with the covenant level: at a 6.50x covenant the prepayment is 6.50 times the EBITDA cure.
This article is one calculation from How to Read a Credit Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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