Mid-market leveraged finance: Covenant trends & key themes

This article is third in a series of five which look at some of the deal and document trends the Shoosmiths leveraged finance team have seen in the mid-market in 2025. Please get in touch with Shoosmiths’ leveraged finance team if you would like to discuss anything in this article.

 

Adjustments, resets and (over)cures

We now see very few deals in the mid-market which don’t include a debt service cover ratio alongside a leverage test. There is more emphasis on financial covenant definitions generally and particularly on adjustments to EBITDA which have further developed latterly as both lender and borrower clients become more aware and cautious (respectively) of the impact they can have on covenants. In the same vein we’re also seeing caps on R&D capitalisation in certain business types. Often these financial covenant controls are implemented in exchange for flexibility elsewhere. Caps on acquisition synergies and exceptionals are becoming tighter typically ranging from 10% to 25% of EBITDA on our deals in Q1 and Q2, with the agreed percentage generally correlating with borrower strength and size.

We are seeing both voluntary and automatic covenant resets. Voluntary resets generally follow a permitted acquisition and require certification of covenant forecasts. Re-sets can apply to any financial covenant, but we typically see them applied to leverage. Methodologies for agreeing updated numbers vary and are often the subject of heavy, bespoke negotiation. Automatic updates are more likely to operate as a ratchet with fixed numbers depending on levels of facility utilisation (sometimes using EBITDA figures and applying a pre-agreed headroom). ‘Agreements to agree’ are not enforceable so a clear methodology is required, and we always recommend including backstop numbers, or a backstop lender decision. EBITDA-based incurrence ratio resets continue on some deals. For example, if EBITDA reaches a certain level, leverage can increase by an agreed percentage. We still see a pure EBITDA test being used to re-set permitted (grower) baskets.

Equity cures are often not restricted, but negotiations around their application are common. Lenders will always be keen to keep visibility of actual business performance. Sometimes overcures are required to be applied as synthetic prepayments. Traditional lenders generally require at least a percentage of the cure to pay down loans, but other lenders are often more flexible. There is often flexibility for shareholder injections to be made outside of an equity cure, but some lenders are beginning to challenge this type of pre-emptive cure.

We’re expecting the changes to the treatment of operating leases from next year to create some short term noise, whilst the market settles on any knock on impact on covenant testing.