A covenant is a legally binding promise or agreement made by a borrower (in this case, a startup) to a lender (in this case, an investor) as a condition of a loan or investment. Covenants in startup funding are typically used to protect the interests of the investors and ensure that the startup is meeting certain conditions or milestones in order to secure additional funding or avoid defaulting on the loan.
Covenants can be either positive or negative. Positive covenants are agreements that the borrower must take certain actions, such as maintaining certain financial ratios or achieving specific milestones. Negative covenants, on the other hand, are agreements that the borrower cannot take certain actions, such as issuing additional debt or selling assets without the lender's consent.
Some common examples of covenants in startup funding include maintaining a certain level of profitability, achieving a minimum level of revenue, not incurring more debt, or not issuing additional shares without the investors' consent.
Covenants can be a powerful tool for investors to ensure that the startup is using the funds raised in an appropriate manner and is on track to achieve its goals. However, it can also be restrictive for the startup, as it limits their flexibility in how they use the funds, and can also be difficult to comply with, especially for young companies with limited resources.