Leveraged finance terms interviewers expect you to know

Most people prep for LBO interviews by memorizing the model: sources and uses, debt schedule, returns. Then the interviewer asks what happens when the company trips a maintenance covenant, and the memorized model doesn't help. The vocabulary of credit is where LBO interviews actually separate candidates, because it's the part you can't fake from a template. This is the short list of terms that come up constantly, what each one means, and why anyone cares.

Maintenance vs. incurrence covenants

A maintenance covenant is a promise the company has to keep on a schedule. Every quarter, tested automatically, whether the company did anything or not. The classic one is a leverage test: net debt to EBITDA must stay below, say, 5.0x. If EBITDA falls and the ratio drifts above the line, the company is in technical default even though it never missed a payment.

An incurrence covenant only gets tested when the company takes a specific action: issuing new debt, paying a dividend, selling assets, making an acquisition. Do nothing and the covenant sits dormant forever. The company can deteriorate badly without ever failing a test, which is exactly why lenders who accept incurrence-only packages charge for it.

The reason this pair matters in interviews: it maps onto who is lending. Banks hold loans on their balance sheets and want the early-warning system, so bank debt carries maintenance covenants. Institutional investors and high yield bondholders trade in and out and can't practically run quarterly check-ins on hundreds of borrowers, so their paper is incurrence-only. When someone says a deal is "cov-lite," they mean the term loan dropped its maintenance tests and runs on incurrence covenants alone. It does not mean there are no covenants, and saying so is a known way to get marked down.

If you want the mechanics of how incurrence packages actually permit things, the basket system is covered in how incurrence covenant baskets work, and the head-to-head comparison has its own page: maintenance vs. incurrence covenants.

Term Loan A vs. Term Loan B

Same company, same seniority, same security. The difference is who buys it, and everything else follows from that.

Term Loan A is held by banks. Banks want their money coming back steadily, so a TLA amortizes for real, often 5 to 10 percent of the balance a year, and it carries the maintenance covenants described above. Shorter tenor, tighter leash, cheaper pricing.

Term Loan B is sold to institutional investors, mostly CLOs and credit funds. Those buyers want yield and duration, not amortization checks, so a TLB amortizes at a token 1 percent a year with the whole balance due at maturity. Covenant package is looser, tenor is longer, and the spread is higher to pay for both. In sponsor deals the TLB is usually the workhorse tranche.

The interview version of this question is rarely "define TLA." It's "why does TLB price wider than TLA at the same seniority," and the answer is the profile: more principal outstanding for longer, fewer covenants protecting it. Full comparison: Term Loan A vs. Term Loan B. Two features that ride along with TLBs are worth knowing on their own: original issue discount and the excess cash flow sweep.

Interest coverage vs. fixed charge coverage

Interest coverage is the simple one: EBITDA over interest expense. Can the business pay its interest out of operating earnings, and how many times over.

Fixed charge coverage asks a harder question: can the business pay everything it's contractually on the hook for. The numerator usually starts with EBITDA and subtracts capex the company can't skip; the denominator adds mandatory amortization, lease payments, and sometimes cash taxes on top of interest. Exact definitions vary by credit agreement, which is itself a point worth making in an interview, because it shows you know these ratios are negotiated terms rather than laws of physics.

A company can look comfortable on interest coverage and tight on fixed charges. A capex-heavy business with an amortizing TLA is the standard example. Interviewers use this pair to test whether you think about cash obligations or just recite one ratio. Side-by-side treatment: interest coverage vs. fixed charge coverage.

Credit stats are forecasts, not report cards

Leverage and coverage ratios get taught as snapshots. Lenders don't use them that way. A 6.0x leverage number means something completely different on a business growing EBITDA 15 percent a year than on one shrinking, because the lender's real question is where the ratio is going over the life of the loan and how much headroom exists against the covenant line if projections slip.

This is the mindset shift that makes covenant questions click. A covenant level is set against a forecast, with negotiated cushion. When you hear "the sponsor negotiated a 35 percent cushion to the model," it means the maintenance test was set so EBITDA can miss plan by 35 percent before tripping. The forward-looking framing is covered here: why credit stats are forward-looking.

Control premium

The one M&A term in this list, because it shows up in the same interviews and gets butchered the same way. A control premium is the amount a buyer pays above a target's unaffected share price to own a controlling stake. Offer $65 for a stock trading at $50 before deal rumors and the premium is 30 percent. The formula is just offer price over unaffected price, minus one. The word doing the work is "unaffected": if the stock already ran up on leak or speculation, measuring the premium off the current price understates what the buyer is really paying.

Why does control deserve a premium at all? Because control is the right to change things: replace management, redirect cash flow, capture synergies, sell the company. A passive share doesn't carry those rights, so it trades cheaper than the whole company is worth to an owner. This also explains a favorite follow-up: precedent transactions run higher than trading comps because precedent deals have control premiums baked in. Definition and formula: control premium.

How these actually come up

Almost never as flashcard definitions. The pattern is a chain: you'll be asked to walk through an LBO, and somewhere in the debt schedule the interviewer interrupts with "is that loan cov-lite?" or "what happens in year 3 if EBITDA misses and the maintenance test fails?" The chain continues based on what you say. Mention a waiver and you'll get asked what the lenders extract for it (a fee, a spread bump, sometimes tighter terms). Mention TLB and you might get asked who buys it. Each term in this guide is a link in those chains, which is why learning them as isolated definitions undersells what they're for.

If you want to drill them the way they get asked, the markets question bank has each of these as a standalone question with a full answer, and adjacent instruments like PIK toggle notes and call protection round out the stack.

FAQ

What actually breaks a maintenance covenant? Arithmetic, not misconduct. EBITDA falls or debt rises, the tested ratio crosses the negotiated line on a quarterly test date, and the company is in technical default. What follows is usually negotiation rather than catastrophe: a waiver or amendment, paid for with fees, a higher spread, or tighter terms.

Why do TLB lenders accept looser covenants? Because of who they are. CLOs and credit funds hold hundreds of positions and trade them; they have no desk for running quarterly covenant checks and amendment negotiations on each one. They accept incurrence-only packages and get paid for it through a wider spread and near-zero amortization.

Is a control premium always paid? No. It applies when a buyer is acquiring control of a public company. Minority stake purchases don't carry one, true mergers of equals can have little or none, and if the target's price already reflects deal speculation the visible premium can be misleading in both directions.