Educational content only. This post explains general structure of loan covenants. It does not constitute legal or financial advice for any specific loan. Consult a commercial loan broker or lawyer experienced in healthcare practice financing before signing loan documents.
When you sign a commercial loan to fund your practice, you're not just agreeing to make payments. You're agreeing to a set of ongoing rules that govern how you operate the business for the life of the loan. These rules are called covenants, and they're typically buried in dense loan documentation that most first-time borrowers sign without fully reading.
Years later, when something happens that bumps up against a covenant — a slow year, a large equipment purchase, a decision to take a bigger draw than usual — the borrower discovers what they actually agreed to. Sometimes the consequences are minor. Sometimes they're material.
This post explains the covenants commonly found in healthcare practice loans, what they require, and which ones are worth pushing back on at the term sheet stage.
What Covenants Are For
A covenant is a contractual obligation built into the loan agreement. From the lender's perspective, covenants protect their position throughout the loan term, not just at closing. The lender funded the loan based on certain assumptions about the practice; covenants are how the lender makes sure those assumptions remain valid.
If the practice's financial position deteriorates, the lender wants to know. If you take on additional debt that affects your ability to service the existing loan, the lender wants the right to weigh in. If the business is sold or majority ownership changes, the lender wants to be involved in approving the new structure.
Covenants give the lender these rights without requiring them to refinance the loan or formally renegotiate every time something changes.
Affirmative Covenants: Things You Must Do
Affirmative covenants require the borrower to actively do certain things during the loan term.
Provide periodic financial statements. Most commercial healthcare loans require annual financial statements, often within 90 to 120 days of fiscal year end. Some require more frequent reporting — quarterly statements, monthly bank reconciliations, or interim updates if specific events occur.
Provide tax returns. Annual personal and business tax returns are typically required, often submitted at the same time as financial statements.
Maintain insurance. Commercial property insurance, professional liability, and sometimes specific business interruption coverage are typically required throughout the loan term, with the lender named as additional insured on relevant policies.
Maintain banking relationships. Some loans require the borrower to maintain primary operating accounts with the lending institution. This is sometimes negotiable but is a common requirement.
Notify the lender of specific events. Material litigation, regulatory actions, significant changes in practice ownership or management, or other defined events typically trigger reporting obligations.
Maintain professional licensure. For healthcare practice loans, the borrower's professional licensure status is fundamental to the practice's ability to operate, and most loans require notification if licensure issues arise.
Financial Covenants: The Numbers You Must Hit
Financial covenants are the most consequential and the most negotiable. They specify financial metrics the practice must maintain.
Minimum DSCR. Most commercial healthcare loans require maintenance of a minimum debt service coverage ratio, commonly in the 1.20–1.40 range. Measured annually through the financial statements you provide.
Maximum debt-to-equity ratio. Some loans cap the practice's total debt relative to equity, limiting your ability to take on additional borrowing without lender consent.
Minimum net worth or retained earnings. Some loans specify minimum levels of accumulated retained earnings or net worth in the practice, ensuring the business doesn't get hollowed out through excessive owner distributions.
Maximum owner distribution. Some commercial healthcare loans cap how much the owner can take out of the practice as distributions or salary above a defined threshold. This protects the lender's position by ensuring cash stays in the business.
Financial covenant breach is the most common covenant issue practices encounter. A bad year can drop DSCR below the threshold. A large equipment purchase can affect debt-to-equity. Understanding the specific thresholds and how they're calculated before signing is essential.
Negative Covenants: Things You Cannot Do
Negative covenants restrict specific actions without lender consent.
Limits on additional debt. Most commercial loans restrict the borrower from taking on additional debt above defined thresholds without lender approval. This affects everything from a new equipment loan to a line of credit to vehicle financing run through the practice.
Restrictions on asset sales. Selling significant practice assets — major equipment, real estate, investment holdings — typically requires lender consent.
Restrictions on ownership change. Selling or transferring ownership interests, bringing in partners, or undergoing major structural change in the practice typically requires lender approval. Most healthcare practice loans treat a change in ownership as a default event unless specifically approved.
Restrictions on related-party transactions. Significant transactions with related parties (family members, related entities, owner's other businesses) sometimes require disclosure or approval.
Operational restrictions. Some loans restrict significant changes in business operations — changing legal entity structure, materially changing the practice's clinical scope, or relocating to a new premises.
What Covenant Breach Actually Looks Like
Most operators imagine covenant breach as a binary event — you breach, the lender calls the loan. In practice, the response varies considerably.
The lender's typical first action after detecting a breach is a conversation. They want to understand what happened, whether it's temporary or structural, and what the borrower's plan is. Most breaches resolve at this stage with no formal action.
If the breach is more material, the lender may issue a formal waiver. The waiver acknowledges the breach but agrees not to take action, often with conditions — modified covenants going forward, additional reporting, sometimes a fee or rate adjustment. The relationship continues but on slightly different terms.
For more serious or recurring breaches, the lender may require specific remediation: additional collateral, a capital injection, a guarantor change, or restructured terms. This is typically a multi-month process that can be disruptive to operations.
In rare cases, the lender accelerates the loan — demanding full repayment immediately. This is most common when the breach is structural (the practice cannot service the loan), where the borrower has been non-cooperative, or where multiple breaches have stacked up. Acceleration typically forces the borrower to refinance with a different lender, sell the practice, or wind down the business.
What to Negotiate
Loan covenants are typically more negotiable at term sheet stage than borrowers realize. Some specific items worth pushing on:
Covenant levels. A 1.30 DSCR covenant is materially different from a 1.40 covenant. Even a 0.10 difference in the threshold can convert a future breach into a non-event. If you have negotiating leverage, push for the lower threshold.
Cure periods. Most covenants specify how quickly a breach must be cured. Longer cure periods give you more flexibility to address temporary issues without formal lender involvement.
Reporting timelines. Standard timelines for delivering financial statements (often 90–120 days post fiscal year end) can usually be extended modestly if you negotiate.
Distribution covenants. If the lender wants to cap owner distributions, the threshold is usually negotiable. The borrower wants flexibility to manage personal cash flow; the lender wants assurance the business stays funded. Finding a level that works for both is typically possible.
Carve-outs from negative covenants. Specific exceptions to debt limitations or asset sale restrictions can often be negotiated. For example, equipment leases below a defined dollar threshold can be carved out of the "additional debt" restriction.
Sunset provisions. Some covenants can include sunset provisions that release them after specific milestones — for example, financial covenants that lift after the practice maintains DSCR above a defined level for a defined number of consecutive years.
The Practical Discipline
Once you sign a loan with covenants, those covenants govern your business for the life of the loan. Most operators don't reread their loan agreement after closing. They should.
Building a habit of running your DSCR calculation each year before submitting financial statements helps surface potential breaches early. So does discussing significant events — large equipment purchases, expansion plans, ownership changes — with your lender before they happen rather than after.
Lenders are generally more flexible when borrowers communicate proactively than when issues surface in financial statements without warning. The borrower who calls before something happens is treated differently than the borrower the lender discovers it from after the fact.
If you're considering refinancing to escape tight covenants on an existing loan, the Refinancing Calculator compares your current loan terms against potential replacement scenarios. The Capital Structure Tool models alternative structures for new loans before you commit to specific covenant terms.
Disclaimer: Covenant structures, thresholds, and lender practices described are drawn from published commercial lending sources and represent general patterns. Specific loan terms vary considerably by lender and deal. KlinDeck is not a lender, broker, lawyer, or financial advisor. Content is educational only. Consult qualified professionals before signing loan documents.