What Football Manager's Board Teaches About Loan Covenants

The most uncomfortable phone call I made as an underwriter was not a decline. It was to a bakery owner, eighteen months after we had approved her equipment loan, to tell her she was in default. She had never missed a payment. Not one. What she had done was take out a second loan from an online lender to buy a delivery van, without telling us, and her loan agreement said she could not add debt above a set amount without the bank's consent. She had signed it. She had never read that page.

I have thought about her often, and lately in an odd context. A friend who plays Football Manager obsessively described the moment his board refused to let him spend over his wage budget and threatened his job when the club's debt grew. He was furious with the game. I told him he had just met the loan covenant, and that most small business owners meet it for the first time in a much worse way than he did.

The board is a lender that lives in your building

In Football Manager, you run the squad, but the board controls the money. It sets a transfer budget and a wage budget at the start of the season. You can ask to move money between the two, and you can ask for more, but the board decides. It also sets expectations, such as a league finish, and keeps a running measure of its confidence in you. Overspend, run up debt or miss targets for long enough and you are sacked, regardless of how well you think you are doing.

A business loan works much the same way, with the lender in place of the board. The monthly payment is the obvious part. The covenants are the rest: promises in the loan agreement about how you will run the business while you owe the money. Break one and the lender can treat the loan as in default even if every payment has arrived on time.

The three kinds of rules in a loan agreement

Almost every commercial loan I underwrote contained some mix of three types of covenant. The game happens to have a version of each.

Financial covenants: the wage budget

These are numbers you must stay inside. The most common one for small business loans is a debt service coverage ratio, usually a minimum of 1.20 or 1.25. In plain terms, for every $1 of annual loan payments, your business needs to generate at least $1.20 to $1.25 of cash available to pay it. Others set a maximum on total debt against earnings, or a minimum cash balance. These are tested on a schedule, often annually for small loans and quarterly for larger ones.

In the game, the wage budget is the equivalent. Your board does not care that the new striker is worth it. It cares that the total wage bill stays under the figure it set.

Reporting covenants: the board meeting

You agree to send the lender information on time: year-end financial statements within, say, 120 days, tax returns, sometimes quarterly figures. This is the one owners most often break by accident, simply by being late. It is also the one lenders are most likely to waive, because it usually signals disorganisation rather than trouble.

Negative covenants: the transfer embargo

These are things you agree not to do without permission. No additional debt above a threshold, no selling major assets, no change of ownership, sometimes limits on what the owners can take out of the business. This is where my bakery owner tripped. In Football Manager terms, she signed a player the board had explicitly blocked.

Why "just make the payments" is incomplete advice

A lot of small business advice reduces a loan to its payment. Keep up the payments and you are fine. That is true for most consumer credit and some simple online business loans. It is not true for bank term loans, SBA loans or most lines of credit, which carry covenants precisely because the lender cannot watch you every day.

The payment tells a lender you paid last month. The covenants are the lender's early warning system for next year. When coverage drops from 1.6 to 1.15, the business can still pay, but the cushion is nearly gone. A lender who learns that from a covenant test can work with you while there is still time. A lender who learns it from a missed payment usually cannot.

A covenant breach is not the lender trying to catch you out. It is the lender's board meeting, and it is far better to be in the room for it.

What actually happens after a breach

In the game, a board that loses confidence sacks you. Real lenders are rarely that dramatic, at least at first. In my experience the options, roughly in the order they get used, are a written waiver, sometimes with a fee of a few hundred dollars; an amendment that resets the covenant for a period, often with a slightly higher rate; extra collateral or a personal guarantee; and only at the far end, calling the loan.

The bakery owner got a waiver, a $750 fee and a stern letter, mostly because her numbers were still healthy and because she was honest on the call. Had she been struggling, the second loan would have looked very different. I wrote more about what the bank is watching in what a lender reads into your business bank statements.

The worst outcomes I saw came from owners who discovered a breach themselves and said nothing, hoping the next test would come out fine. Lenders find out. When they find out late, waivers get much more expensive.

Read your own covenant page this week

Find your loan or line of credit agreement and look for a section titled covenants, or terms like "affirmative," "negative" and "financial." Write down every number and every deadline you find: the coverage ratio, any debt limit, the date your annual statements are due. Put the dates in your calendar and work out roughly where your business stands against each ratio today. If you are close to a limit, call your lender before the test, not after. If you are still shopping for a loan, ask to see the covenant terms before you sign, and compare them alongside the rate. My piece on how a term loan and an SBA loan differ covers where covenants tend to be stricter, and what a personal guarantee bets on you explains the other promise most owners sign without reading closely.