Equity Cure Provisions in Middle-Market, Sponsor-Backed Credit Agreements By Taylor Smith, Partner, Davis Graham & Stubbs, LLP An “equity cure” is a type of legal provision often found in credit agreements governing loans that finance acquisitions by private equity sponsors. In an alignment of interests between lenders, private equity sponsors, and their portfolio company borrowers, these provisions allow sponsors to retroactively cure their portfolio companies’ financial covenant defaults by making a cash equity contribution typically treated as a dollar-for-dollar increase to the company’s adjusted EBITDA in the amount necessary to cause compliance with the company’s financial covenants for the applicable measurement period. Equity cure provisions benefit all parties involved by providing a clear protocol for navigating economic downturns or other periods of financial difficulty in a manner that prioritizes de-risking the lender’s credit exposure while protecting the company’s viability and sustaining the sponsor’s commitment to the success of the business. This article summarizes common market practice for equity cure provisions in middle-market, sponsor-backed credit agreements. The vast majority of secured credit agreements with sponsor-backed borrowers will contain one or more financial ratio covenants. For example, a leverage ratio covenant requires that, as of the end of each calendar quarter, the ratio of the borrower’s funded debt to the borrower’s adjusted EBITDA for the trailing four-quarter period must not exceed a specified level. If the borrower’s adjusted EBITDA for the measurement period is insufficient to keep the leverage ratio under the specified maximum level, an automatic event of default will result, entitling the lender to exercise all legal remedies available to a secured creditor, including accelerating the loans and foreclosing on the borrower’s assets. A fixed charge coverage ratio is another common financial ratio covenant that uses adjusted EBITDA in the numerator of the ratio and is, therefore, susceptible to cure through a retroactive deemed increase to adjusted EBITDA. A typical equity cure provision will provide that, concurrently with the delivery of the borrower’s quarterly financial statements and compliance certificate demonstrating the applicable financial covenant breach under the credit agreement, the sponsor may deliver to www.coloradobankers.org 14
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