Security, covenants and surety

What lenders take as security

A mortgage bond over property is the strongest and cheapest form, because property is durable and realisable. A notarial bond over movables covers equipment, vehicles and plant, and can be general or specific. A cession of book debts gives the lender first claim on money owed to the business by its customers — unremarkable until the day it means the lender collects your debtors directly.

A pledge of shares puts shares in the company itself up as security, which means enforcement transfers ownership. A negative pledge takes nothing but forbids the business from granting security to anyone else, protecting the lender's position from being diluted by a later facility. It costs nothing today and constrains every future funding decision.

Two questions are worth asking of any security package. What is genuinely being encumbered, and what does that prevent the business doing later? A general notarial bond over all movables can make a subsequent asset finance facility impossible, which is a substantial cost that appears nowhere in the pricing.

Financial covenants

Covenants are promises about how the business will perform and behave. Financial covenants are tested against the numbers, usually quarterly.

The common ones are debt service cover (cash available to service debt, against the payments due), gearing or debt-to-equity (how much debt sits against shareholder funds), interest cover (earnings against interest), and sometimes a minimum net asset value.

The critical point is not which covenants apply but how much headroom exists. A covenant set tightly against the business plan will be breached the first time a quarter disappoints — and covenant breach is a default, whether or not a payment was ever missed. A business can be paying perfectly and still be in default.

So the negotiation worth having is not about removing covenants, which lenders will not do, but about setting them against a pessimistic case. A lender would generally rather agree realistic headroom upfront than manage a technical default six months in.

Negative and information covenants

Negative covenants forbid specified actions without consent: taking on further debt, granting security elsewhere, disposing of assets, paying dividends, changing control, or making acquisitions. Each is reasonable in isolation, and together they can constrain a business considerably more than the owner anticipated.

Information covenants require reporting — management accounts monthly or quarterly, annual audited financials, covenant compliance certificates. These are the most commonly breached covenants in owner-managed businesses, not through concealment but because nobody is tasked with producing them on time. Late reporting is a technical default and it damages the relationship precisely when goodwill has value.

Personal surety

A surety is a personal undertaking by the owner to pay the debt if the business does not. It moves the lender's claim beyond the company and onto the individual: house, savings, personal assets.

It is close to universal in South African small and mid-market lending, and it is not predatory. A lender advancing against a business with limited security is asking the owner to share the risk they are being asked to take.

But it deserves a deliberate decision. Three things are worth establishing before signing. Is it limited or unlimited — capped at a stated amount or covering everything owed, including future facilities? Is it joint and several with co-owners, meaning the lender can pursue any one surety for the full amount rather than each for their share? And what releases it — is there a mechanism to have it discharged once the business meets defined conditions, or does it persist indefinitely?

A limited, releasable surety and an unlimited, joint-and-several one are entirely different commitments described by the same word.

What to do before signing

Four practical steps consistently improve the terms a business ends up with, and none requires leverage.

Model the covenants against a bad case. Not the plan — the plan minus a poor quarter. If a covenant breaches under that scenario, ask for the headroom now rather than a waiver later, when it will cost a fee and some goodwill.

Map what the security encumbers and what that prevents later. A general bond over all movables can foreclose a future asset finance facility.

Name the person responsible for reporting before signing. Late reporting is the most common technical default in owner-managed businesses and it is entirely avoidable.

Read the surety separately from the facility, on a different day if possible. It is a personal commitment and it deserves to be assessed as one rather than as the last page of a business document.

Default, cross-default and cure

Default is broader than missing a payment. It typically includes covenant breach, late reporting, material adverse change, insolvency events, and cross-default.

Cross-default is the clause that most often surprises. It means default under any other facility constitutes default under this one. A dispute with an equipment financier can therefore put the primary bank facility into default, and a small problem becomes a systemic one within days.

Cure periods are the counterweight — a window to fix a breach before consequences follow. Negotiating a realistic cure period, and the right to remedy a financial covenant breach by injecting shareholder funds, is one of the more valuable and least contested asks in a facility agreement.

If a business does find itself in this territory, the options are set out in financial distress options. The single most useful thing to know is that early contact with a lender consistently produces better outcomes than late contact, because a lender's worst scenario is being surprised.