Negative covenants are restrictions in loan, bond, or credit agreements that prohibit specific actions by the borrower unless the lender waives them.

How it works

Venture debt term sheets often include negative covenants such as: no additional indebtedness above a threshold, no dividends or distributions, no sale of core IP, maintenance of minimum cash balances, and limits on liens or collateral grants. Affirmative covenants require positive actions — deliver financials, maintain insurance — while negative ones forbid behaviors that could impair repayment.

In private equity, credit agreements layer extensive negative covenants on portfolio companies. Preferred stock can include analogous restrictions on recapitalizations or senior financings through protective provisions.

Waivers are negotiable but may carry fees or tighter terms. An event of default can accelerate repayment, trigger equity conversion in convertible instruments, or freeze additional borrowing until the company cures the breach or renegotiates.

Why it matters

• Founders: Read covenant baskets before signing venture debt. A planned acquisition or large customer prepayment might violate cash covenants if not forecasted with the lender.
• Investors: Lenders and late-stage investors use negative covenants to guard downside. Equity investors should know whether debt covenants constrain follow-on rounds or exit timing.

Common mistake

Treating covenants as boilerplate. A “no additional debt” clause can block an emergency bridge or equipment lease unless you obtain a waiver in advance.

Related ideas

See also event of default, affirmative covenants, venture debt, and protective provisions.