Meaning
Contractual remedies in venture debt and bank loans allow shareholders to prevent or repair a financial covenant breach by injecting new capital into the business. An equity cure provision dictates the conditions under which the company can treat a fresh cash investment as earnings or debt reduction for the purpose of covenant calculation. This mechanism protects the firm from a sudden default and preserves the founder’s control during a temporary revenue downturn.
Its application is strictly confined to the specific calculation periods and ratios defined in the loan document.
Funding Mechanism
Capital calls must be completed within a short window, often fifteen days after the delivery of a financial report showing a breach. Under an equity cure provision, the cash injected by shareholders is added directly to EBITDA or used to pay down outstanding debt. This adjustment recalculates the leverage or interest coverage ratio, bringing the company back into compliance.
The cost to the existing shareholders is the immediate deployment of cash reserves that could have funded growth.
Dilution Risk
Issuing new shares to fund the cure changes the ownership distribution of the company. When an equity cure provision is used, it often requires a down round or a highly dilutive internal round because the firm is in a weak negotiating position. Founders face a reduction in their ownership percentage as the price of avoiding a lender takeover.
This equity shift is the primary cost of using the remedy.
Structural Limit
Lenders restrict the frequency of this remedy to prevent chronic underperformance from being masked by continuous capital injections. An equity cure provision is typically limited to a few instances over the life of the loan. This constraint forces the board to address operational failures.
