Equity cure

An equity cure is the repair of a breach of a debt covenant by injecting equity funding into the borrowing company, or the right to do so. Such agreements are popular with private equity investors, but lenders are often reluctant to agree to them.

It is obvious that selling shares to investors to raise money will improve balance sheet ratios, and this will avoid breaches of debt covenants. This is not what equity cures are about.

What equity cures do is to allow capital raised through the issue of equities to be used to make up a shortfall in revenues, cash flow or profits. This needs to be permitted by the terms of the debt covenant.

Lenders can be wary of debt covenants because they often provide a one-off solution to a continuing problem. The effect of an equity cure is to delay the action the lender can take to recover the debt because of the breach.

Equity cures are often associated with private equity ownership because the of combination of concentrated ownership (which makes this type of rescue action likely) and high gearing (which makes breaches of covenants likely).