Equity Cure
An equity cure is a credit-agreement right allowing a borrower or its equity owner to contribute qualifying equity after a financial covenant breach and have the covenant recalculated under specified cure mechanics.
Equity cures protect against technical covenant default
A temporary earnings decline can cause a maintenance covenant breach even when the sponsor is willing to inject additional capital.
The cure mechanism gives equity owners a defined opportunity to restore compliance before lenders exercise default remedies.
The accounting treatment is contractual
Some agreements increase EBITDA by the cure amount for covenant purposes. Others require the cash to reduce debt or specify a different treatment.
The cure does not retroactively change reported financial statements.
Frequency limits prevent unlimited cures
Current agreements can cap the number of cure rights over the life of the facility and restrict how frequently they can be used.
Without those limits, repeated equity injections could mask persistent covenant underperformance.
The cure amount can be isolated from other capacity
Credit agreements may state that cure proceeds are not available to increase restricted-payment, investment or debt capacity.
That prevents the same equity contribution from curing a covenant and simultaneously expanding other baskets.
An equity cure changes lender rights more than enterprise economics
Suppose a borrower misses a leverage covenant because EBITDA falls from $100 million to $80 million while debt remains $400 million. Leverage rises from 4.0× to 5.0×.
If the covenant maximum is 4.5× and the agreement permits a $10 million cure amount to be added to EBITDA, covenant EBITDA becomes $90 million and leverage falls to about 4.44×.
The cure restores compliance, but the company still has $400 million of debt and only $80 million of actual operating EBITDA.
That distinction matters in credit analysis: the legal default can be cured even while underlying credit quality remains weaker.
Common mistakes
Treating a cure as improved operating EBITDA It is a contractual adjustment.
Assuming the sponsor can cure indefinitely Frequency limits are common.
Ignoring the cure deadline Cash usually must be received within a stated period.
Example
A borrower fails a maximum leverage covenant because quarterly EBITDA is too low. Its sponsor contributes $15 million of common equity before the cure deadline. The agreement permits that amount to be added to covenant EBITDA solely for the relevant test, bringing the ratio back into compliance.
Example
A borrower fails a maximum leverage covenant because quarterly EBITDA is too low. Its sponsor contributes $15 million of common equity before the cure deadline. The agreement permits that amount to be added to covenant EBITDA solely for the relevant test, bringing the ratio back into compliance.
Professional note
An equity cure can fix a covenant calculation without fixing the underlying operating weakness. Analysts should show the ratio before and after cure and track how often the sponsor has used the right.
Related terms
- Sponsor Equity Contribution
A sponsor equity contribution is the capital a private equity sponsor or its affiliated fund contributes to an acquisition vehicle to fund the portion of a transaction not covered by debt, rollover equity or other permitted sources.
- Financial Maintenance Covenant
A financial maintenance covenant is a credit-agreement requirement that a borrower satisfy a specified financial ratio or threshold on recurring test dates, such as quarter-end, regardless of whether the borrower is incurring new debt or taking another restricted action.
- EBITDA Add-Back
An EBITDA add-back is an adjustment permitted by a credit agreement that increases covenant or adjusted EBITDA by reversing specified expenses, losses or charges or by including certain expected cost savings, synergies or other contractually allowed amounts.
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