Understanding modern debt funding: Structures, covenants and lenders

A guide

Debt funding is a vital tool for businesses seeking growth, acquisition, or working capital, but with numerous types of structure, regulations and sources, the topic can often generate confusion.

In this guide, our experts demystify how modern debt funding works, providing an overview of the most common structures, how covenants really work, and comparing banks and alternative lenders. Whether you’re a founder, CFO, adviser or investor, this content should provide clarity around debt funding so that you can harness it effectively to support the right goals.

How does modern debt funding work?

Debt funding refers to the borrowing of funds in various forms including loans, credit lines, bonds, or notes, with repayment of both principal and interest over a fixed term. Unlike equity funding, ownership is retained, but lenders will closely assess affordability, risk and cashflow sustainability, as well as measuring performance against an agreed range of covenants and conditions.

Debt funding discussions typically begin with an examination of the business’s financial profile, focusing on both historic performance and future projections around the following:

EBITDA: Often the primary metric for assessing affordability.
Turnover: Used as an indicator of scale and resilience
Cashflow: This should ideally be stable or growing, with sufficient headroom.

Presenting a clear and credible financial narrative of the business is imperative. Lenders are more flexible than in the past, and more inclined to tailor solutions around the borrower’s situation. Nevertheless, they still expect well-supported forecasts and a strong understanding of how facilities will be serviced across different trading scenarios. Key preparation should typically include:

A clear funding requirement and use of proceeds (e.g. growth, acquisition, working capital, refinance), including the preferred type of debt funding.
A detailed business plan with prior year, current year and three year forecasts (profit and loss, balance sheet and cashflow), supported by realistic assumptions.
Evidence of affordability and headroom, including downside scenarios to demonstrate an understanding of the levers available to management if things go off track, and where relevant, draft covenant calculations such as leverage and interest cover.
A strong grasp of your business model and value drivers, including market drivers, strategy, management team roles, capability and execution risks.
Working capital and concentration analysis, showing how customer/supplier concentration, seasonality and trading volatility could impact cash generation and covenant performance.

Typical debt structures

Common structures include:

Term loans: Provide lump sums of cash that borrowers must repay over a set period and fixed schedule.
Revolving credit facilities: Flexible funding option which allows businesses to withdraw and repay portions of a credit line whenever needed, commonly includes an overdraft carve-out.
Asset-backed lending: Loans secured against a business’s assets such as inventory, debtors or property.

For growth-stage companies, lenders may offer bullet repayments or interest-only periods, easing cash flow strain during expansion. Growth is never linear, so the role of deal advisers when structuring these facilities is to ensure the business has flexibility and headroom for both good and bad times.

Bank of England interest rate

The Bank of England’s base rate currently stands at 3.75%. Following steady declines since July 2024, it has reached its lowest level since January 2023. Nevertheless, this figure remains considerably higher than the 0.5% average recorded between 2009 and 2022. Although rates were anticipated to decrease further by Spring 2026, the ongoing conflict in Iran and the Middle East, coupled with its resulting inflationary pressures, may cause rates to remain fixed (or even rise) for the remainder of the year.

What do covenants mean in practice?

Covenants are conditions placed on the borrower to protect the interest of the lender within the loan agreement. They can also be seen as promises made to lenders around how the business functions and its overall financial health. Covenants can be both backward looking (based on Management Accounts), or forward looking (based on projections over the next 3-12 months). They include limits on:

Interest coverage
Cash flow cover (or debt service)
Leverage (Net Debt : EBITDA)
Annual Capital Expenditure

It’s important to note that covenants aren’t there to trip borrowers up, rather, they serve the purpose of flagging to those involved that the business is steering off track. The breach is then a trigger for a discussion as to why, helping identify the issue and how it can be fixed.

What happens when a covenant is breached?

In the event of a breach, lenders will work with the borrower to find a solution, either through a restating of the covenant, or an action to correct it, this could be an injection of fresh capital or a reduction in a facility value.

Successful renegotiation should result in either a covenant reset, or a covenant waiver being issued. However, if the borrower and lender cannot reach an agreement, the only remaining option would be to call the facility and issue a demand of repayment.

This is why a thorough understanding of covenants is vital for any business, as is robust financial modelling and transparent, proactive communication between advisers and lenders.

Traditional banks vs alternative lenders: What’s the difference?

The rise of alternative lenders, such as debt funds, private credit providers, and specialist finance houses, has transformed the funding landscape. Choosing between them really comes down to the individual business and its requirements. The two types of lenders primarily differ around the following:

Risk appetite

Alternative lenders typically have a higher risk appetite than traditional banks, often prioritising higher-margin loans and moving more swifty. Whereas traditional banks remain conservative, preferencing stable cash flows and strong asset cover due to their regulatory nature and stricter requirements.

Pricing and flexibility

Alternative lenders tend to charge higher interest rates and fees to reflect the heightened risk and their additional flexibility, while traditional banks offer more competitive rates and rigid requirements.

Specialisms

Alternative lenders may offer more bespoke services, focusing on niche, high-risk sectors that banks are less likely to value or understand, such as technology, healthcare and creative sectors.

Founders and CFOs must weigh speed, flexibility, and cost when choosing between the two.

Closing thoughts

For businesses today, debt funding is no longer a one-size-fits-all proposition, instead, owners should engage early with funders and experts to carefully assess cost of funding, cashflow and covenants, to ensure the debt aligns with their long-term strategic objectives.

How can Price Bailey help

Price Bailey’s Corporate Finance team supports businesses through the full debt lifecycle, from selecting the right facility structure and lender group, to negotiating covenants and supporting ongoing compliance. We can help you to:

Define the funding requirements and design an appropriate structure (term loan, RCF, ABL, unitranche/private credit), including tenor, amortisation and security considerations.
Build integrated financial models and scenarios to proof affordability and covenant headroom (including downside and sensitivity analysis).
Prepare robust lender materials that clearly explain the cash flow story and use of proceeds.
Run a structured funding process, identifying suitable banks and alternative lenders, managing Q&A, and helping you compare terms beyond headline pricing.
Support covenant and documentation negotiation by focusing on definitions, testing mechanics, reporting requirements, cure rights and waiver processes.
Provide ongoing support post-completion, including management reporting improvements and lender-facing covenant compliance packs, drawing on our wider audit, tax and outsourcing teams where needed.

With access to a broad network of funders, from tier-one banks to alternative lenders, we help clients approach the market with confidence and secure the facilities that best support their long-term goals.

For more tailored advice or guidance around your specific situation, get in touch with a member of our Corporate Finance team using the form below.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.

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