Many bank loans are going to have covenants associated with them, particularly longer term loans.

These covenants can take many different forms, including:

1. Net worth. Bank may require you to keep a certain minimum amount of net worth in the company.

2. Working capital. May be required to keep certain levels of working capital in the business or have certain working capital ratios showing the relative amount of current assets versus current liabilities.

3. Income statement performance. This could be a requirement that you generate a certain amount over and above where your interests and perhaps even your debt payment requirements are.

4. Spending covenants. These might limit spending on things such as capital expenditures.

5. Other covenants. Other financial covenants that the bank might see fit to have in place.

Often these covenants will be based upon certain financial forecasts that you gave when you took down the loan. Now, the bank will usually give you some breathing room. They won’t set the covenants right at the forecast level.

One lesson is to be aware of what you’re getting into with the covenants and how much breathing room do you have. Which of the covenants appear to be the tightest and are the closest to what you projected? Do you have the ability?

How much breathing room do you have on the particular covenants? How much could income fall, for example, or how much does your working capital have to change?

Are you tracking these covenants in your financial reporting package? You want to keep these front and center. It can be easy to have this be out of sight and out of mind after the loan’s been closed. And before you know it, you’ve forgotten what are the covenants requiring to be kept? By putting them in the financial statement package, you keep yourself aware of what these covenants are and how close you are to tripping the covenants.

The bank should use some breathing room in covenants and should there be a default you should have a certain amount of time given after they notify you to rectify the situation whether it could be to raise more capital or more training of personnel.

Know what you’re getting into with the banks and covenants and keep track of it so it doesn’t creep up on you and become a surprise at the wrong time.