Covenant EBITDA vs adjusted EBITDA: what the credit agreement counts
By Derwin Lucas ·
Covenant EBITDA is EBITDA as the credit agreement defines it, for the borrower group, over the test period. It is the figure a leverage covenant is tested on and the one a compliance certificate reports. Most agreements build it up from consolidated net income; the demonstration agreement starts from reported EBITDA, as management’s adjusted EBITDA does. Either way, it then follows the agreement’s own list: which adjustments are permitted, which are capped, which need a certificate, and what an acquired company contributes for the months before it was owned.
The two figures are often close, and closeness is the risk. A board that reads adjusted EBITDA as the covenant figure is reading a number the lender doesn’t test. This guide works through one leverage test from Goverisyn’s demonstration portfolio, with synthetic inputs and a synthetic credit agreement, line by line.
One leverage test, line by line
Exhibit 1. Covenant EBITDA for the borrower group, twelve months to June 30, 2026, $ thousands (demonstration portfolio, synthetic inputs)
| Line | Claimed | Included | Treatment under the agreement |
|---|---|---|---|
| Reported EBITDA | – | 8,020 | The brands’ 10,559 less the holding company’s 2,539 |
| Unusual or nonrecurring charges | 24 | 24 | Permitted, inside the aggregate cap |
| Litigation settlements | 36 | 25 | Capped at $25k a test period |
| Permitted acquisition costs | 38 | 38 | Permitted, outside the cap |
| Run-rate cost savings | 90 | – | Not supported: no officer’s certificate held in the record |
| Pro forma for an acquisition | 79 | 79 | One brand’s months before it was owned: $73.6k from the seller’s statements and $5.0k of transaction adjustments; two months not covered |
| Owner compensation | 76 | – | Not permitted |
| Covenant EBITDA | 343 | 8,186 | Reported EBITDA plus the 166 included |
Of $343k of adjustments claimed, $166k is included. Leverage is net debt of $28,500k, also synthetic, divided by covenant EBITDA of $8,186k: 3.48x, against a maximum of 4.50x. Both inputs are synthetic, so this is a worked example of the test, not a compliance reading. At the same net debt, covenant EBITDA could fall $1,853k, or 22.6%, before leverage reaches the maximum. That is the limit’s arithmetic, not a forecast. The figure is also incomplete in a stated way: one brand’s June is absent from reported EBITDA and two pre-acquisition months from the pro forma, and the direction of either is not known.
Set the same twelve months on the other definitions and the figures sit close together: $8,194k management-accepted, $8,118k governed, $8,186k covenant. The covenant figure is $68k above governed because it adds $79k of pre-acquisition earnings that governed leaves out, and gives back $11k to the litigation cap. It is $8k below management’s because it excludes the $76k of owner compensation and the $11k over the cap, and adds the $79k. Each figure is correct on its own definition, and none of them can stand in for another.
Four ways the EBITDA definition in a credit agreement changes the figure
1Caps
Some adjustments are permitted only up to a limit, one kind at a time or in aggregate. Here litigation settlements are capped at $25k a test period, so $11k of a $36k claim falls away, and the aggregate cap is 15% of a defined base: $1,221k, of which $49k is used. The litigation cap binds, removing $11k; the aggregate cap does not. In a year with a large restructuring charge, the aggregate cap is often the line that decides the covenant figure.
2Conditions
Run-rate cost savings are forecasts, and agreements commonly admit them only with conditions: a time limit for realizing them, a cap, and a certificate from a named officer. The $90k claimed here is left out because no certificate is held in the record. The saving may be real. The agreement’s condition for counting it hasn’t been met.
3Pro forma for acquisitions
When a brand is acquired during the test period, the agreement usually lets the borrower count its earnings for the months before it was owned. Those months come from the seller’s statements, not the platform’s books. Here the $79k covers six months and leaves two uncovered, and the record says so. Pro forma earnings are a different kind of figure from the rest of the line, and they should be shown as one.
4Exclusions
Some adjustments management accepts are not permitted at all. In this synthetic agreement owner compensation is one of them, so the $76k management adds back is left out entirely. Real agreements vary, and the definition in the agreement is the one that governs.
The covenant figure is the agreement’s definition applied line by line, and nothing else.
Build the compliance certificate line every month, not only at the test
The compliance certificate is usually prepared in the weeks after a quarter closes, from the same schedules each time and often by the same person. When that person leaves, or a brand converts its accounting system, the next certificate is rebuilt from what can be found. The lender reads only the result.
In Goverisyn, the covenant line is computed from reported EBITDA under the agreement’s definition as recorded, each adjustment shown as claimed and as included, with the reason for any difference. It is stated beside management’s and the governed figure, each on its own basis, and the record also shows what it doesn’t hold: in the demonstration, the March 31 test has a covenant EBITDA but no net debt and no certificate recorded. Net debt is entered only as the sponsor-designated finance officer verifies it at a test date.How the board pack states the covenant line
What this guide does not claim
It is not legal advice and does not interpret any real credit agreement. Whether a covenant is met is the borrower’s certificate to give and the lender’s determination to make; Goverisyn declares no compliance. The agreement, the net debt and every figure here are synthetic, and the treatments shown are those of the demonstration agreement, not a statement of market terms.
Where a reconciliation should begin
Take the agreement’s EBITDA definition and list every adjustment it names. For each, record the amount claimed, the amount the definition allows and why. Caps, certificates and pro forma months are where the covenant figure and management’s figure part ways, so they are where a reconciliation should start.
How each add-back is classified before it reaches the covenant line is covered in EBITDA add-backs: which ones hold up, and the questions a lender asks of the whole figure in Adjusted EBITDA diligence questions. Goverisyn’s Portfolio Measurement Review tests a documented basis across selected brands, after a free 45-minute Portfolio Review.
More guides on financials
EBITDA comparability across portfolio companies
EBITDA growth since acquisition: separating performance from changes in basis
Adjusted EBITDA diligence questions for home-services roll-ups
EBITDA add-backs: which ones hold up, and the record that shows it
Sell-side quality of earnings: what to have on record before the review begins
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By Derwin Lucas, founder of Goverisyn, with a career in management and information systems in home services. Published . About Goverisyn