How CFOs Add Value Through Leverage, Covenants & Negotiation

🛠 THE CFO EFFECT PLAYBOOK (Part II)

Understanding lender psychology

Most finance leaders think lenders are in the business of lending money.
They’re not.
They’re in the business of managing risk.

Capital deployment is just the mechanism.

When you understand that, your entire negotiation approach changes.

A lender is essentially running three mental checklists before they loosen any terms, extend more credit, or drop your rate:

1. Predictable repayment: “Will I get my money back on time?”

This is the non-negotiable.

A lender doesn’t care how brilliant your product is or how hot your industry looks.

If your repayment looks unpredictable, you’re a higher risk.

What predictability looks like to a lender:

• Stable, recurring cash flows (subscription revenue, long-term contracts).

• Historical consistency in meeting payment schedules.

• Conservative forecasts that you’ve historically exceeded.

• Early-warning signals in your reporting package (e.g., variance analysis that’s proactive, not reactive).

CFO Play:
Treat your repayment schedule like a sacred commitment.

If you ever need flexibility, the credibility bank you’ve built here is what you’ll draw on.

Example: I once worked with a seasonal retailer who negotiated a 90-day interest-only holiday every January–March.

They got it approved because they had an eight-year record of flawless payments and never blindsided the bank.

2. Collateral security: “If you miss payments, do I have a safety net?”

Collateral is the lender’s insurance policy.

It’s not that they want to take your assets.

Trust me, taking your assets is the last thing a banker would do.

But they need to know that they can if they have to.

I had a client once who told me: “You’re not taking any risk; you are fully secured by my assets”.

I told: “I’m not in the business of selling assets. I’m in the business of getting repaid by strong cash flows. If I foreclose on your assets, they become a liability more than anything else.”

Don’t wave your assets as if they were a treasure.

The only reason a business owners value their assets is because they know how to create value and generate cash flows by using those assets.

A banker has no ability or expertise to do so.  

What good collateral looks like to a lender:

• Assets with stable or appreciating value (real estate, marketable securities).

• Liquid or near-liquid assets (cash, AR with strong collection history, high-turn inventory).

• Clear title and low risk of legal disputes.

What weak collateral looks like:

• Niche machinery with limited resale value.

• Inventory that’s slow-moving, perishable, seasonal, or at high obsolescence risk.

• Receivables from customers with poor creditworthiness.

CFO Play:
Boost perceived collateral value by improving the underlying asset quality before negotiations.

Example: An e-Com brand I advised increased their inventory advance rate from 35% to 50% simply by segmenting their borrowing base to exclude slow-moving SKUs.

The lender saw higher value and reduced liquidation risk.

3. Borrower credibility: “Do I trust this management team?”

Here’s the intangible that turns “no” into “yes” more often than any spreadsheet.

This is by far, the most important factor in the lender’s checklist.

Your financials and the performance of the company is just the translation of managerial decisions.

No amount of financing will cure a company from bad decisions from bad management.

Credibility is built in every interaction.

What builds credibility:

• Transparency when things go wrong (tell them before the numbers show it).

• Proactive risk mitigation plans. Don’t wait for the bank to ask you for one.

• Clear, concise communication: no jargon, no burying the bad news.

• Demonstrating you understand the importance for the banker and demonstrate you want to help.

CFO Play:
Think of your lender as a long-term investor.

You’re not just reporting numbers, you’re selling confidence in your ability to navigate storms.

Example:

A manufacturing CFO I know secured a $2M increase in their revolver during a down quarter because they came in with a detailed cash flow recovery plan, cost cuts already executed, and revised forecasts.

The lender didn’t see a struggling borrower.

Instead, they saw a competent operator with control of the wheel.

Bottom Line for CFOs:

If you want more favorable rates, looser covenants, or higher borrowing capacity, don’t start with the term sheet, start with reducing perceived risk in:

1. Predictability of repayment.

2. Security of collateral.

3. Credibility of management.

Do that consistently, and you’ll find lenders not just willing to accommodate, but often offering better terms before you even ask.

The main covenant types

Covenants aren’t just legal fine prints.
They are control levers your lenders can pull if they feel their risk is increasing.
Some are straightforward.

Others quietly dictate how fast you can grow, invest, or pivot.

Understanding each type and how it impacts day-to-day decisions is essential for every CFO.

1. Financial covenants

What they measure:

• Leverage Ratio: Total Debt ÷ EBITDA.

• Interest Coverage Ratio: EBITDA ÷ Interest Expense.

• Debt Service Coverage Ratio: EBITDA ÷ (Interest + Principal Payments).

Impact on operations:
These are the covenants that directly influence how much you can borrow, when you can borrow more, and how much cash you must retain.

If your leverage ratio has a 3.0x ceiling and your business is sitting at 2.8x, every new investment has to be measured against the risk of breaching that limit.

Strategic risk:

• Restricts growth investments when financial metrics tighten.

• Can force management into defensive moves (cost cuts, asset sales) to stay in compliance.

• In downturns, these are the covenants most likely to be breached first.

Example:
A SaaS company with 90% gross margins tripped a leverage covenant during a sales slowdown.

Even though they were cash flow positive, the breach triggered a “default” clause, forcing them into emergency negotiations for a waiver.

This increased their risk profile which had a negative impact on their interest rate.

Overall, their borrowing costs crippled their cash flow further.

CFO Play:
Negotiate headroom into financial covenants to absorb seasonal or economic volatility.

Most CFOs spent too much time negotiating interest and not enough time discussing the language of the credit agreement.

Don’t expect your lawyer to help you negotiate the commercial aspect of your credit agreement.

Make sure you negotiate covenants that don’t restrict your growth or your business moves.

Most importantly and what CFOs of mid-market companies never do is negotiate the definitions in the covenants.

How you define your EBITDA can be the difference between no credit line during hard times and a lifeline when you need it the most.

2. Affirmative covenants

What they measure:
Actions you must take, such as:

• Maintaining certain insurance coverage.

• Delivering financial reports by set deadlines.

• Paying taxes on time.

Impact on operations:
Usually low day-to-day impact.

These are operational “must-do’s” that rarely limit strategy, unless you neglect them.

If anything, these are actions that you should be taking anyway.

Strategic risk:

• Missed compliance erodes lender trust, even if your financials are solid.

• Habitual sloppiness here can make lenders less flexible when you need a concession later.

Example:
A mid-market retailer missed quarterly reporting deadlines twice in a year.

Even though they were profitable, the bank flagged them as a “monitor more closely” account.

This not only makes future negotiations harder but could increase the interest rate due to higher risk.

Do not jeopardise the cash flows of your business because you’re not on top of bank reporting.

CFO play:
Build a covenant compliance calendar owned by finance.

Ensure reporting and operational requirements are met early, not just on time.

3. Negative covenants

What they measure:
Restrictions on actions you cannot take without lender approval:

• No acquisitions or asset sales.

• No new debt issuance.

• No dividend payments or stock buybacks.

Impact on operations:
These can slow decision-making on major strategic moves.

Want to acquire a competitor? You may need to seek lender consent first.

Strategic risk:

• Slows execution on time-sensitive opportunities.

• Lender may impose conditions (e.g., raise equity first, adjust repayment schedule) before approving moves.

CFO play:
Negotiate “permitted baskets” pre-approved limits for acquisitions, dividends, or new debt that you can execute without prior consent.

What I do on my side is negotiate a clause that says that the restrictions only apply if they create a financial covenant breach.

4. Performance covenants

What they measure:
Operational or financial performance tied to:

• Revenue growth.

• EBITDA margins.

• Customer churn rates (common in SaaS).

Impact on operations:
They link borrowing capacity or interest rates directly to business performance.

Hit your targets, and you may unlock more capital or lower rates.

Miss them, and credit availability can shrink exactly when you need it most.

Strategic risk:

• Volatility in demand or margins can reduce available credit unexpectedly.

• Can trigger a liquidity squeeze in a downturn even without a breach of financial covenants.

Example:
An e-Com company had a revolver tied to quarterly EBITDA targets.

A supply chain delay caused a 15% EBITDA miss, which instantly cut their borrowing base by $1.2M, right in peak inventory season.

CFO play:
Avoid overly tight operational targets in loan agreements.

If unavoidable, build seasonality adjustments or look-back periods into the covenant language.

CFO insight

In reality, these covenants don’t exist in isolation.
You might have all four types in the same agreement; each with its own risks.

The strategic CFO’s job is to:

• Map every covenant and identify which will be pressure points in different economic scenarios.

• Negotiate for headroom and flexibility where it matters most.

• Maintain perfect compliance on low-impact covenants to preserve goodwill for when you need to push back on high-impact ones.

Leverage, ROE, and Valuation – The CFO’s balancing act

Leverage is one of the most misunderstood tools in corporate finance.
It’s not just about how much debt you have.

It’s about what that debt allows you to do and the return you generate from it.

When managed well, leverage can be a value amplifier:

• Higher leverage (within safe limits) can increase Return on Equity (ROE) by funding growth with borrowed capital instead of diluting shareholders through new equity.

• It can also expand valuation multiples if investors see leverage as a sign of confidence and growth efficiency.

But the flip side is dangerous:

• Over-leverage magnifies downside risk, increases the probability of covenant breaches, and can push you into refinancing under distress (when capital is expensive and terms are punishing).

• It increases fixed costs and your breakeven point, adding more risk to the business.

• It can force equity raises at unattractive valuations, permanently eroding shareholder value.

Your job as CFO isn’t to avoid leverage.
It’s to engineer the optimal level where ROE is maximized without putting the business in a fragile, covenant-bound position.

CFO Play: Calculating the “Sweet Spot”

To find your optimal leverage point:

1. Model ROE sensitivity to changes in leverage: identify where the incremental return starts to flatten or reverse.

2. Overlay covenant headroom and cash flow volatility to ensure resilience in a downside case.

3. Build scenario plans for 12, 24, and 36 months so leverage strategy aligns with both short-term operations and long-term growth.

Negotiation tactics: How to win better terms

1. Frame your story around risk reduction

Lenders don’t reward optimism.

They reward credible risk mitigation.
When you walk into a negotiation, you’re not just presenting numbers.

Instead, you’re reassuring the lender’s credit committee that your risk profile is shrinking, not expanding.

Prove It With:

• Historical consistency in cash flows and show stability across multiple years, including downturns.

• Conservative forecasts that you’ve consistently beaten.

• Early warning systems that highlight how you monitor risks before they escalate.

2. Use performance metrics as leverage

If you’ve outperformed expectations, it should be used as currency in negotiations.

• Outperformance vs. your own projections shows operational excellence.

• Outperformance vs. industry benchmarks shows competitive advantage.

CFO play:
Come armed with metrics that directly reduce lender risk:

• Higher inventory turnover (reduces collateral risk).

• Lower DSO (faster cash conversion).

• Stable or rising gross margins (pricing power).

3. Ask for what you’ll need in 12–18 months, not just today

Too many CFOs negotiate covenants that fit today’s balance sheet and P&L… then end up renegotiating from a position of weakness when growth accelerates.

Why this matters:
Imagine buying an umbrella during sunny days.

The price is lower, and you probably can negotiate with the sellers because they’re trying to get rid of their excess inventory.

Now, imagine it’s raining, and you need an umbrella. You’ll buy the first one at any price.

It’s the same thing when it comes to financing.

Get your financing during sunny days, when your bargaining power is at it’s highest.

When you’re growing fast, your capital needs, and your covenant flexibility need to scale ahead of the curve.
If you wait until you need the flexibility, your leverage in the conversation is gone.

CFO Play:

• If you expect revenue to double in 18 months, negotiate covenant levels and facility sizes that anticipate that growth now.

• Build in step-ups: automatic adjustments to covenant thresholds based on revenue or EBITDA milestones.

CFO Insight – leverage is a strategic weapon

Leverage, covenants, and negotiation terms are all parts of the same equation:

• Leverage drives ROE and growth capacity.

• Covenants define your operational runway.

• Negotiation strategy determines how much flexibility you actually have to maneuver.

Master all three, and you turn your financing agreements from a constraint into a competitive advantage.

CFO Insight – The hidden ROI of negotiation

Every CFO knows how to raise money.
Few know how to expand capital access without raising new funds.
Covenant and leverage negotiations are one of the most overlooked ways to create instant financial flexibility, often with zero dilution and minimal cost.

Next Week’s Episode:

🔜 3-step Capital Structure Health Check

Most companies don’t fail because they run out of ideas.
They fail because they run out of oxygen.
And in business, oxygen = capital.

But here’s the twist: it’s not just about having capital.
It’s about having the right mix of debt and equity on your balance sheet.

Too little equity, and lenders see you as reckless.
Too much equity, and you’re leaving returns on the table.

Next Sunday, I’ll walk you through a 3-step Capital Structure Health Check every CFO should run:

✅ Why equity is the most expensive capital you’ll ever raise (and how to use it wisely)
✅ How to strike the right balance between debt and equity: avoiding both fragile structures and “lazy” balance sheets
✅ The quick ratio tests and stress scenarios you can run this week to know if your capital structure is truly aligned with your strategy

Because capital structure isn’t just a number.
It’s the steering wheel that determines how far (and how fast) your company can grow.

If you’re ready to make sure your balance sheet isn’t silently suffocating your business, you can’t miss this episode.

Disclaimer:
This content is for informational and educational purposes only and should not be construed as financial, legal, or professional advice. Always consult with a qualified advisor before making any business or financial decisions. The author and publisher disclaim any liability for actions taken based on this content.

Talk soon,