Equity Cure Rights Explained: How a Sponsor Cures a Covenant Breach, Why an EBITDA Cure Costs Six Times Less Than Paying Down Debt, and the Caps That Stop It Becoming an Evergreen Crutch
Michael King, PE Investment Manager · 9 min read ·
- An equity cure lets the sponsor inject fresh equity that a credit agreement treats — for the covenant calculation only — as additional EBITDA or as debt prepayment, curing a financial-covenant breach before it becomes an event of default
- The deleveraging cure always costs the leverage covenant multiple times more than the EBITDA cure. At a 6.0x net-leverage covenant, curing the same breach costs £5M as a deemed-EBITDA cure or £30M if the cash must repay debt — a mathematical relationship, not a negotiated one
- An EBITDA cure fixes the ratio, not the balance sheet: actual net debt is unchanged, so the business is no more solvent the day after the cure than the day before. That is why lenders cap the right
- Standard caps limit cures to roughly five over the life of the facility and no more than two in any four consecutive quarters, with an anti-double-count so the deemed EBITDA cannot also inflate baskets, the pricing grid or the cash-sweep calculation
What an Equity Cure Actually Does
An equity cure is a contractual right, written into the credit agreement, that lets a private equity sponsor rescue a financial-covenant breach by putting new money into the borrower. When the leverage or coverage test trips, the sponsor injects equity — or deeply subordinated shareholder debt that ranks behind the lenders — and the agreement deems that cash to increase EBITDA or reduce net debt for the purpose of the failed test. The breach disappears on paper, and the loan does not accelerate.
The point is not the accounting. The point is control. Without a cure, a tripped maintenance covenant hands the lender a default, and with it a seat at the table and the leverage to reprice, restructure or enforce. The cure converts that default into something far less dangerous to the sponsor: a capital call on the fund. The equity holder writes a cheque and keeps the keys.
Two Ways to Cure, and They Do Not Cost the Same
Credit agreements build the cure one of two ways, and the difference is the single most valuable thing to understand about the mechanic.
An EBITDA cure — the sponsor-friendly form, and now the market standard on larger deals — treats the injected cash as an addition to EBITDA for the covenant test. It lifts the denominator of the leverage ratio without requiring the company to do anything with the money. A deleveraging cure — the lender-friendly form — requires the cure proceeds to be applied in prepayment of debt, so the ratio improves because net debt genuinely falls.
A Worked Breach: £5M or £30M for the Same Quarter
Take a business bought with £300M of net debt against £50M of EBITDA — 6.0x, sitting exactly on a 6.0x net-leverage covenant with no headroom. A soft quarter drops trailing EBITDA to £45M. Net debt is unchanged, so measured leverage jumps to 6.67x. The covenant is breached.
| Cure route | What the sponsor must inject | Post-cure covenant leverage |
|---|---|---|
| EBITDA cure | £5M — deemed EBITDA rises to £50M | £300M / £50M = 6.0x |
| Deleveraging cure | £30M — net debt falls to £270M | £270M / £45M = 6.0x |
Both routes read as 6.0x on the compliance certificate. Only one of them changed the company. After the EBITDA cure the business still carries £300M of debt against £45M of real earnings — its actual leverage is still 6.67x, and it is no closer to being able to service that debt than it was before the cheque cleared. That gap between the reported ratio and the underlying reality is the entire reason lenders fight to limit the right.
Why the Right Is Caged: Caps, Frequency and the Anti-Double-Count
A cure right with no limits would render the covenant meaningless — a sponsor could paper over permanent decline quarter after quarter and the lender would never get its early warning. So the agreement caps it, and the caps are where the negotiation happens.
Three restrictions are close to universal. There is a lifetime cap — typically no more than four or five cures over the whole term of the facility. There is a frequency cap — commonly no more than two cures in any four consecutive quarters, which stops a company from curing every single test date. And there is an anti-double-count: the deemed EBITDA counts only for the covenant test, and is stripped out of every other calculation that references EBITDA — the cash-sweep and excess-cash-flow mechanics, the pricing grid, and the incurrence baskets that govern further debt or restricted payments. Without that carve-out, a sponsor could inject £5M and simultaneously loosen the margin, shrink the sweep and unlock new debt capacity — all off one cheque.
The Cure Is a Capital Call, Not a Repair
The reason this matters beyond the documentation is that an equity cure is a decision about the fund's money, taken under pressure, on an asset that has just missed plan. The first cure is usually easy: a good business had a soft quarter, £5M protects a large equity position, the partners write it without much debate. The second and third are the ones that separate disciplined sponsors from stubborn ones.
A cure does not fix the operating problem that caused the breach; it buys a quarter. If the miss was genuinely one-off, the quarter is enough and the business recovers. If the decline is structural, serial cures are the classic sunk-cost error — throwing fresh equity into a capital structure that is slowly failing, protecting an option that is quietly going out of the money. The frequency cap exists precisely because lenders know sponsors are tempted to defend a losing position, and at some point the lender would rather have the default and the negotiating leverage that comes with it. When cures run out or stop making sense, the conversation moves to the tools in the next tier — an amend-and-extend, a covenant reset, or the broader menu of liability management exercises.
The Verdict: A Release Valve With a Ceiling
The equity cure is one of the cleaner examples of how a credit agreement allocates control rather than just money. It hands the sponsor a way to keep a maintenance covenant from becoming a default, which is worth a great deal when the miss is temporary — the fund pays a small insurance premium to avoid surrendering leverage over its own asset. But it is deliberately built so it cannot be leaned on: the caps make sure that a business in real trouble eventually reaches the lender's table anyway, cure right or not.
Read that way, the cure is not a loophole in the covenant — it is part of the same bargain. The maintenance test gives the lender an early date; the cure gives the sponsor a limited right to postpone that date by putting equity behind its conviction; and the caps make sure the postponement is limited. Each side is buying and selling the same thing: time and control when the plan starts to slip.
How It Is Tested in Interviews
Shown a downside case where the leverage covenant trips, the weak answer says "the deal is broken." The strong answer asks about the cure: is there one, is it an EBITDA cure or a deleveraging cure, how many are left, and how much equity does it take to get back inside the test. Better still, the candidate notes that a deemed-EBITDA cure leaves actual leverage untouched — the ratio is fixed, the balance sheet is not — and frames the decision as a capital call the fund must be willing to fund, not an automatic fix.
Take Your Preparation Further
The cure sits inside the covenant package, so start with Debt Covenants and Cov-Lite Explained for maintenance versus incurrence tests and headroom, then read The LBO Debt Stack for where in the structure the covenant bites. For what happens when cures run out, see Liability Management Exercises and Restructuring Interview Questions.
Download the free Restructuring Primer for the distressed-side mechanics, and use the LBO Model Template to build the downside case where the covenant trips and see how much equity actually cures it.
Ready for personalised feedback? Book a 1-on-1 mentoring session with an experienced IB/PE professional.
Frequently asked questions
What is an equity cure right?
An equity cure right is a clause in a leveraged credit agreement that lets a private equity sponsor remedy a breach of a financial covenant by injecting fresh equity, or deeply subordinated shareholder debt, into the borrower. For the purpose of the failed covenant test only, the agreement deems that cash to increase EBITDA or to reduce net debt, which brings the leverage or coverage ratio back inside its limit. The practical effect is to convert what would otherwise be an event of default — and the control that hands the lender — into a capital call on the fund, so the sponsor keeps ownership of the asset by paying to protect it.
What is the difference between an EBITDA cure and a deleveraging cure?
An EBITDA cure treats the injected equity as additional EBITDA for the covenant calculation, lifting the ratio's denominator without requiring the company to do anything with the cash. A deleveraging cure requires the cure proceeds to be applied in prepayment of debt, so the ratio improves because net debt actually falls. The two are not equivalent in cost: for the same relief the deleveraging cure is larger by exactly the leverage covenant multiple, because the EBITDA cure moves the denominator while the debt cure must move the much larger net-debt numerator. At a 6.0x covenant a £5M EBITDA cure and a £30M debt paydown fix the identical breach. Sponsors prefer the EBITDA form; lenders prefer the paydown.
How many times can a sponsor use an equity cure?
Standard credit agreements cap the right in two ways at once. A lifetime cap limits the total number of cures over the term of the facility — typically four or five. A frequency cap limits how often they can be used — commonly no more than two in any four consecutive quarters — which prevents a borrower from curing at every test date. The caps exist because an uncapped cure right would make the maintenance covenant worthless: a sponsor could paper over permanent decline indefinitely, and the lender would lose the early warning the covenant is meant to provide. When the caps are exhausted, a further breach becomes a genuine default.
Does an equity cure actually fix the business?
No — an EBITDA cure fixes the covenant ratio, not the balance sheet. Because the deemed-EBITDA form does not require the cash to repay debt, actual net leverage is unchanged the day after the cure: a company that breached at 6.67x still carries the same debt against the same real earnings, even though its compliance certificate now reads 6.0x. The cure buys a quarter of time. If the miss was genuinely one-off, that is enough for the business to recover; if the decline is structural, serial cures are a sunk-cost trap — fresh equity poured into a capital structure that is slowly failing. The frequency cap is the lender's protection against exactly that.
Why do lenders agree to equity cure rights at all?
Because a capped cure right is a reasonable trade for both sides. The lender keeps the maintenance covenant and its early-warning date; in exchange it grants the sponsor a limited number of chances to postpone a default by putting real equity behind its conviction that a miss is temporary. If the sponsor is right, the lender is repaid on schedule and the equity injection has strengthened the credit. If the sponsor is wrong, the caps ensure the borrower still reaches the lender's table before too long. The anti-double-count — deemed EBITDA counting for the covenant test but not for the pricing grid, cash sweep or debt-incurrence baskets — is what stops the sponsor from extracting more from one injection than the clause was meant to give.