If you’re a founder about to sign a term sheet for a bank loan, credit facility, or venture debt deal, here’s the thing nobody tells you at the term-sheet stage: the interest rate is not the part of the deal that will hurt you later.
The part that hurts is buried in the covenants — the rules you agree to live under for the next three to five years. Most founders spend 90% of their negotiating energy on pricing and 10% on everything else. It should be the other way around.
Here’s a plain-English walk-through of what actually matters, and what you should push back on before you sign anything.
1. The interest rate is just the headline number
Yes, negotiate your margin. But two things matter more than the rate itself:
- Rate floors. If your lender wants a minimum interest rate (a “SOFR floor”) even when benchmark rates drop, that’s a one-way bet in their favor. If you can’t remove it, at least cap it at a low level and trade it for a better rate elsewhere.
- Default interest. Ask exactly when the higher “default rate” kicks in. You want it to apply only if you miss a payment, not automatically the moment you’re late filing a compliance report. A lot of loan documents let a paperwork slip quietly double your interest rate.
2. Prepayment: don’t let the loan trap you
You should always be able to pay off your loan early without penalty, full stop. If a lender wants a fee for early repayment (common in venture debt and some private credit deals), make sure that fee disappears the moment you get acquired, go public, or hit a major milestone. A loan that punishes you for a successful exit is a loan working against your incentives, not with them.
Watch for lenders requiring long notice periods before you can prepay. Push for the shortest window possible, and make sure you can pull the notice back if a refinancing falls through.
3. “Covenants” are really just rules about how you’re allowed to run your company
This is the part that gets skipped over fastest and matters most.
Financial covenants are performance thresholds you have to hit (a maximum debt-to-earnings ratio, for example). Two questions decide whether these will bite you:
- How much cushion do you have? If the covenant is set right at your current projections, you’re one soft quarter away from a default. Push for at least 25–30% breathing room below your realistic downside case, not your best-case model.
- What happens if you trip one? Ask whether you can fix a covenant miss by having your investors put more cash into the company (an “equity cure”). This is a standard, fair mechanism; make sure it’s in your documents.
Operational covenants limit what you can do without asking permission: taking on more debt, making acquisitions, paying dividends, selling assets. The fix here isn’t to eliminate these limits (lenders won’t agree to that); it’s to make sure your permitted “baskets” the amounts you’re allowed to do without consent actually grow as your business grows, instead of staying frozen at the dollar figure you had on day one.
4. Read your default triggers like your business depends on it, because it does
A loan default doesn’t just mean you missed a payment. Most credit agreements list a dozen ways to trigger one, and some of them are traps:
- “Material Adverse Change” clauses. Some lenders want the right to call a default if something happens that they subjectively believe hurts your business. This is about as one-sided as it gets; a good lender shouldn’t need it, and you should resist it hard.
- Cross-default clauses. These say that if you default on any other debt or contract, even a small equipment lease, you’re automatically in default here too. Push to narrow this so it only applies to real, material debt, and only if that other lender actually accelerates the loan (not just if you were technically late).
- Cure periods. Make sure you get a real window, typically 30 days to fix a covenant problem before it becomes a full default, and that the clock starts when you’re notified, not the moment the slip happens.
5. Your revolver should actually be there when you need it
If part of your facility is a revolving line of credit meant as a safety net, check the conditions for drawing on it during a downturn. Some loan agreements require you to re-certify that “nothing materially bad has happened” every time you draw, which is exactly backward. A revolver is supposed to be your cushion in hard times; a condition like that can lock you out precisely when you need the cash most.
6. Guarantees and collateral: don’t over-pledge
Lenders will want collateral and, often, guarantees from your subsidiaries. Two things to watch:
- Make sure only significant subsidiaries have to guarantee the loan, not every small entity in your corporate structure.
- Push for collateral carve-outs on things that are expensive or impractical to pledge (leased real estate, certain contracts, foreign subsidiaries), so you’re not spending legal fees perfecting a lien on assets that don’t meaningfully improve the lender’s security.
7. Who can end up owning your debt
Loans get sold and traded, just like bonds. Ask for a “disqualified lender” list, a set of named competitors, or funds known for aggressive tactics, who can never buy your debt without your consent. This is cheap to negotiate at closing and nearly impossible to add later, so don’t skip it.
The one habit that protects you more than any single clause
Before you sign, run your actual business plan, future acquisitions, a possible dividend, a new financing round, through the covenants you’re agreeing to. If a plan you’re likely to want to execute in the next two years would require your lender’s permission, that’s a conversation to have now, while you still have leverage, not eighteen months from now when you need an amendment and have none.
Disclaimer: This article is for general informational purposes and isn’t legal advice for any specific transaction. Loan terms vary significantly by lender, deal size, and market conditions — talk to counsel before you sign.