Which of the following is a typical LBO covenant target?

Which of the following is a typical LBO covenant target?

• A. Spent limits
• B. Forced call in the event of a downgrade
• C. EBITDA / Interest > 3x
• D. Debt / EBITDA < 6x

Answer: (D)

In leveraged buyouts, lenders tightly control risk with covenants that limit how much debt the company can carry relative to its cash flow. A standard covenant target is a ceiling on leverage, expressed as debt divided by EBITDA, set at a level like six times. This keeps the debt load aligned with the business’s ability to generate cash, and it’s easy to monitor: if the ratio nears or breaches the cap, management must deleverage or renegotiate terms, protecting lenders. A clause that forces a debt call on a downgrade is more of a rating-trigger or acceleration mechanism than a typical ongoing target. An EBITDA-to-interest ratio is a plausible maintenance measure (ensuring cash flow is enough to cover interest), but the classic, most representative LBO covenant focuses on maintaining leverage below a specified cap, which is why the debt/EBITDA < 6x option is the best fit.

In leveraged buyouts, lenders tightly control risk with covenants that limit how much debt the company can carry relative to its cash flow. A standard covenant target is a ceiling on leverage, expressed as debt divided by EBITDA, set at a level like six times. This keeps the debt load aligned with the business’s ability to generate cash, and it’s easy to monitor: if the ratio nears or breaches the cap, management must deleverage or renegotiate terms, protecting lenders.

A clause that forces a debt call on a downgrade is more of a rating-trigger or acceleration mechanism than a typical ongoing target. An EBITDA-to-interest ratio is a plausible maintenance measure (ensuring cash flow is enough to cover interest), but the classic, most representative LBO covenant focuses on maintaining leverage below a specified cap, which is why the debt/EBITDA < 6x option is the best fit.