When it comes to credit agreements, one term that lenders often include is an equity cure. An equity cure is an agreement between the lender and borrower that allows the borrower to adjust their equity levels in the business to meet certain financial covenants. Essentially, it`s a way for the borrower to inject cash or assets into their business to improve their financial standing and meet their obligations under the credit agreement.
The equity cure provision is often included in credit agreements to provide some flexibility to borrowers who may be struggling to meet their financial covenants. Without an equity cure provision, a borrower could default on their obligations if they fail to meet certain financial ratios or covenants. With an equity cure provision, the borrower has an opportunity to address the deficiency before a default occurs.
For example, let`s say a borrower has a financial covenant requiring the business to maintain a debt-to-equity ratio of no more than 2:1. However, due to a downturn in the market or unexpected expenses, the borrower`s equity decreases, pushing their debt-to-equity ratio to 3:1. In this scenario, the equity cure provision in the credit agreement would allow the borrower to invest additional equity into the business to bring the debt-to-equity ratio back into compliance with the covenant.
It`s important to note that the equity cure provision is not a permanent fix to a borrower`s financial problems. Instead, it`s a short-term solution that allows the borrower to avoid default and buy time to implement a more robust financial plan. In some cases, lenders may limit the number of times a borrower can use the equity cure provision or cap the amount of equity that can be injected into the business.
From a lender`s perspective, the equity cure provision provides some assurance that the borrower is taking steps to address their financial issues. However, lenders also need to be careful in structuring equity cure provisions, as they can impact the lender`s ability to take action in the event of a default. For example, if the equity cure provision requires the lender to provide consent before the borrower can use the provision, the lender may be giving up some of their rights to take action in the event of a default.
In conclusion, the equity cure provision is a valuable tool for both lenders and borrowers when included in a credit agreement. It provides short-term relief for borrowers struggling to meet their obligations and gives lenders some assurance that the borrower is taking steps to address their financial issues. However, it`s important to structure equity cure provisions carefully to ensure that both parties` rights are protected.