A portfolio company's EBITDA has fallen from Rs 100 crore to Rs 70 crore against Rs 480 crore of debt and a 5.5x leverage covenant. How large an equity cure is needed, and should the sponsor put the money in given a plan to recover to Rs 90 crore?

The cure is Rs 95 crore, and on these numbers the sponsor should put it in. Debt must fall to 5.5x Rs 70 crore, Rs 385 crore. Judged as a new investment, the Rs 95 crore buys equity expected to be worth Rs 312 crore in three years, 3.3x, because without it the lenders take everything. It fails a 25% hurdle only if the decline case is more than 52% likely. Ask the lenders for a reset first; it may be cheaper.

A covenant is a ratio, so it can be fixed from either side: more EBITDA or less debt. At Rs 70 crore of EBITDA, 5.5x allows Rs 385 crore of debt, so the cure must repay Rs 480 less Rs 385: Rs 95 crore. Some agreements let cure money count as EBITDA instead, which would need only Rs 17.3 crore here because each rupee of EBITDA is worth 5.5 rupees of debt capacity; lenders limit that for exactly that reason, so read the definition in the agreement. This one applies the cure to debt.

Think of a family that bought a shop for Rs 52 lakh and now needs Rs 9.5 lakh to stop the bank seizing it: what they paid is gone either way, and the question is only whether Rs 9.5 lakh buys something worth more than Rs 9.5 lakh. The sponsor's Rs 520 crore of original equity is sunk; the Rs 95 crore must earn its own return, measured against what the equity is worth with the cure and without it. Without it the lenders can take control and the equity is worth nothing. With it the sponsor keeps a claim on whatever the business becomes.

Run three years from Rs 385 crore of debt. If the plan works, debt falls to Rs 315 crore and 9x Rs 90 crore leaves Rs 495 crore of equity; if EBITDA stays at 70, debt falls to Rs 345 crore and 8x leaves Rs 215 crore; if it falls to 60, leverage reaches 6.2x, the covenant breaks again and the equity is lost. Weighted 50, 30 and 20, the expected equity is Rs 312 crore, 3.28x the cure in three years, an IRR of about 49%.

Yes on these numbers, with two conditions. The cure clears a 25% hurdle of Rs 186 crore by a wide margin and fails only if the decline case becomes more likely than about 52%; even the flat case alone, Rs 215 crore, covers it. First condition: the plan's evidence. A new product range and a cost programme are the two most commonly missed promises in a turnaround, so the deal team should see orders for the new range and named cost lines before it believes 50%. Second: ask the lenders for a covenant reset in exchange for a fee, a higher margin and a smaller paydown; lenders often prefer a sponsor that stays engaged to a business they must run themselves, and a reset may cost far less than Rs 95 crore.

Say the limit too. The flat case leaves leverage at 5.3x after year 1, inside the covenant by a whisker, so one more bad quarter forces a second cure. A fund also weighs concentration: the Rs 95 crore comes from reserves meant for other companies, and the investment committee will ask what it would have earned there.