Equity cure provisions allow private equity-backed borrowers to remedy covenant breaches by injecting equity. This capital infusion is treated as EBITDA for covenant testing. While lenders include this mechanism to grant sponsors more flexibility, the practice raises questions about pricing fairness and long-term outcomes.
Think of equity cures as a “get out of jail free” card with a cost. When a leveraged company trips a covenant – say, its debt-to-EBITDA ratio exceeds the agreed maximum – the sponsor can provide funds to fix the metric on paper. It’s simple in design, yet has important implications.
Equity cure clauses are found in leveraged loan agreements or high-yield bonds. At each covenant-test date – typically quarterly – the borrower calculates a ratio such as Net Senior Debt/EBITDA. If the threshold is breached, the sponsor may inject equity into the obligor or a guarantor. The cure amount is added back to EBITDA for testing, reducing the ratio.
The specifics matter:
While the idea is straightforward, much of the negotiation focuses on source qualification, cure caps, and how cures interact with other covenant baskets. Each term reflects the balance between flexibility and protection.
Equity cures have become common in U.S. leveraged loans. Over 60% of broadly syndicated leveraged buyouts in 2023 included equity cure language, up from 45% in 2021. High-yield bond agreements use cures more cautiously, with approximately 20% adopting cures in recent years.
Sectors differ in their adoption. Healthcare and pharmaceuticals use cures frequently, since regulation or product launches can cause temporary covenant breaches. Industrial and manufacturing deals follow, due to cyclical cash flows and capex peaks that distort leverage metrics.
Technology-enabled services are also prominent. Flexible deal structures and sponsor preference for control during rapid growth make cures useful here. For more on the role of private equity in these and other sectors, see why private equity firms are investing in healthcare.
European markets trail the U.S., as their loan packages often rely more on maintenance tests and margin ratchets. Equity cures appear in about 15% of large-cap European LBOs, which highlights differences in regulation and lending traditions.
For sponsors, cures protect returns by avoiding technical defaults and safeguard capital structure flexibility. Injecting funds can be cheaper than a costly waiver or an “amend-and-extend” deal.
From a lender’s point of view, cures reduce immediate default risk and help maintain fee income, but they might let poor-performing deals persist. This leads to debates on several issues:
To manage these risks, lenders often impose stricter cure caps, restrict cure timing to once annually, and require lock-up periods to prevent sponsors from exiting soon after a cure.
When pricing leveraged loans or bonds, underwriters consider the likelihood and potential size of equity cures. A basic model suggests each dollar of cure availability reduces expected loss given default (LGD) by about $0.15. However, too much cure capacity can reduce yield spreads if lenders underestimate credit risk.
| Cure Cap (% of EBITDA) | LGD Reduction | Approx. Spread Compression (bps) |
|---|---|---|
| 0% | 0% | 0 |
| 10% | 5% | 10 |
| 25% | 15% | 25 |
| 50% | 25% | 40 |
Typically, spread adjustments range from 10 to 30 basis points on broadly syndicated loans, depending on credit quality and sector. Lenders may also charge unused cure fees – up to 25 basis points on available cure capacity – to offset the relaxed covenant.
This structure shows that risk moves from lenders to sponsors, but compensation for that transfer isn’t always precise. Where sponsors have more resources than operating cash flow, the asymmetry is clear.
Case Study 1: Healthcare MBO Uses Cure Effectively
A $1.2 billion buyout of a mid-cap pharma services company included a 20% cure cap per year and a 40% total cap. Delays in lab certification hit revenue and breached a covenant. The sponsor injected $30 million, used it as a cure, and reset expectations. The company returned to compliance without needing a waiver fee.
This case shows cures working as intended – fixing temporary timing issues rather than hiding deeper problems.
Case Study 2: Industrial Carve-Out Leads to Market Correction
A carve-out of an aerospace supplier allowed unlimited cures, only needing board approval. After two successive cures totaling $50 million, lenders forced an amendment: cures were capped at 25% and required proof of actual capital deployment. The sponsor then rolled part of their preferred equity as a cure, which diluted anticipated returns but maintained compliance.
This demonstrates cures taken to the limit – and how lenders respond to restore balance. Check out my article for more information on carve-out transactions.
While equity cures can help avoid technical defaults, they also present clear drawbacks:
The only available studies are limited but notable. In a dataset of 150 LBOs with cure clauses, 35% saw at least one cure within two years, averaging $28 million per deal. Yet just 10% of cures ultimately prevented later need for restructuring.
Rising disclosure standards, real-time reporting, and automated covenant monitoring are changing the discussion. A few new trends are worth noting:
As these trends evolve, the balance of power between sponsors and lenders will likely shift again. For professionals interested in how covenant innovations connect to broader market valuations, see M&A financial modelling and valuation techniques.
Equity cure provisions add short-term flexibility for sponsors and reduce default risk for lenders, but they also blur the lines between financial structure and operating results. As deals become more data-driven, sponsors and lenders must adapt their approach to cures, balancing the benefits of flexibility with the need to protect value.
P.S. – Check out our Premium Resources for more valuable content and tools to help you break into the industry.
