When they say no covenants

I saw a press release yesterday relating to a company that had received a “default and demand” letter from its U.S.-based Venture Debt lender, Hercules Technology Growth Capital. According to the company’s release, the letter had been issued as a result of “material adverse effects”; in essence, the company appeared to miss its internal “sales and EBITDA” forecasts. As is often the norm, according to at least one report, the company may protest the demand, and the circumstances surrounding it.

I’m not privy to the agreement, nor the context for the alleged default, so I can’t comment as to the veracity of either position. And I really despise it when other lenders claim: “oh, we would never do that.” How could you know how you’d act unless you were in the same situation, with the same information?

What I can do is use this as just the most recent in a series of relevant examples where “material adverse change” clauses have come up in venture debt loan documents. Particularly U.S.-led deals, but also certain domestic players as well.

I attend countless conferences and presentations with fellow lenders, and invariably I’ll hear a lender spout that his/her deals have “no covenants” whatsoever. This comes as a constant surprise, as we look at pretty much the same deals as everyone else, and it is rare to see a deal that wouldn’t require even a single covenant.

Unless, of course, the documentation spells out that your company will be in default if there’s been a “material adverse change”, what is commonly referred to as a MAC clause. While many lawyers will say that a subjective covenant is hard to enforce, and therefore one shouldn’t be fussed by such terms, I’ve always been dubious. How is a judge to say that a material miss in your revenue or EBITDA forecast isn’t a material adverse change? Frankly, would could be more material than missing one of the key elements of your financial targets?

As for the comforting words someone might give you (“we’d never use it” comes up alot), all I’ll say is if the lender means what he says and truly won’t ever use the MAC clause, they certainly don’t need it in the legal agreements.