Most founders prepare for a loan negotiation by comparing interest rates. That is a reasonable place to start, but it is rarely where the real risk sits. The provisions that end up costing companies money, control, or even their next financing round are usually the ones nobody reads closely: the covenants, the default triggers, and the fine print about what happens when the business hits a rough patch.
Below are five questions every borrower should be able to answer before signing a term sheet or credit agreement. If you cannot answer one of these confidently, that is the item to raise with your lender or your attorney before you sign.
1. What actually counts as a default?
A loan default is not limited to missing a payment. Most credit agreements list a long menu of events that can trigger one, and some are far broader than borrowers expect.
Two clauses deserve special attention:
- Material adverse change provisions. Some lenders reserve the right to call a default if they believe something has happened that could hurt your business, even without missing a single payment or covenant. This kind of subjective trigger gives the lender enormous discretion and should be resisted wherever possible, particularly as a condition for drawing on a revolving line of credit.
- Cross-default clauses. These provisions say that a default on any other obligation, even something small like an equipment lease, can trigger a default under your loan as well. Ask your counsel to narrow this so it only applies to material debt, and only once that other lender has actually accelerated the obligation rather than merely noticed a technical breach.
2. How much room do I have before I trip a covenant?
If your loan includes financial covenants, such as a maximum leverage ratio or minimum cash balance, ask how much cushion exists between the covenant level and your realistic downside projections, not your best case scenario.
A covenant set close to your current numbers is not a form of protection. It is a countdown clock. Aim for enough breathing room that an ordinary rough quarter does not put you in technical default. And ask whether you have the right to cure a covenant miss by having investors contribute additional capital. This is a standard and fair mechanism known as an equity cure, and it should be part of any reasonable facility.
3. Can I pay this off early without being penalized?
You should generally be free to repay a loan ahead of schedule without a fee. If your lender insists on a prepayment premium, which is more common in venture debt and private credit deals, make sure that premium disappears automatically if you are acquired, complete an IPO, or hit another major milestone.
A loan that penalizes a successful outcome is working against the very goals it was meant to support.
4. What am I allowed to do without asking permission first?
Every credit agreement limits certain activities unless the lender agrees in advance: taking on additional debt, making acquisitions, paying dividends, or selling assets. These limits are normal. The problem arises when the dollar thresholds attached to them are frozen at the number that made sense on day one and never grow with the company.
Before signing, walk your realistic two-year business plan through these limits. If a future acquisition, financing round, or distribution you are likely to want would require your lender’s consent, that is worth negotiating now, while you still have leverage, rather than later when you need an amendment and have none.
5. If I default on a technicality, do I get a real chance to fix it?
Look for a cure period, typically around thirty days, that gives you time to correct a covenant or reporting default before it becomes a full event of default. Confirm that the clock starts when your lender actually notifies you of the issue, not from the date the underlying problem occurred. Without that protection, a missed report or a delayed certificate can quietly run out its own cure period before anyone realizes there was a problem to fix.
In Sum: The habit that matters more than any single clause
The single most useful thing a founder can do before signing a credit agreement is stress test it. Take your actual plans for the business over the next two to three years and check them against the covenants on the table. A loan document is not just a funding instrument. It is an operating agreement you will live inside for years, and the terms you accept at closing are almost always better than the terms you will get later, when you actually need to change them.
Disclaimer: This article is provided for general informational purposes only and does not constitute legal advice for any particular transaction. Loan terms vary by lender, facility size, and market conditions. Borrowers should consult qualified counsel before entering into any credit agreement.
