June 10, 2026 | Financial covenants series
Typical BSL formulation
This tends to be one of the most closely scrutinized EBITDA addbacks, although most of the negotiations relate to the sizing and application of the cap. They are different from many other addbacks because they do not “add back” an expense or otherwise reverse an item that was included in determining the company’s net income. Rather it is adjusting EBITDA today for something that has not, or has not yet fully, impacted the company’s net income. Covenant Review describes the current state of this addback in most sponsors’ broadly syndicated loan (“BSL”) forms as follows:
“… if we think about doing something in the future that could increase EBITDA and think we can get a good start on it in the next [24] months, we get to treat it as if it had happened at the beginning of our test period an also add the full projected amount to our current EBITDA (sort of subject to a 25% EBITDA cap, sometimes).” Source: Covenant Review |
Below is a representative formulation from a sponsor precedent.
(h) the amount of (x) pro forma “run rate” cost savings, operating expense reductions and synergies related to the Transactions that are reasonably identifiable [and factually supportable] and projected by Holdings or the Borrower in good faith to result from actions that have been taken or with respect to which substantial steps have been taken or are expected to be taken (in the good faith determination of Holdings or the Borrower) within [36] months after the Closing Date (including from any actions taken in whole or in part prior to the Closing Date), net of the amount of actual benefits realized during such period from such actions and (y) pro forma “run rate” cost savings, operating expense reductions and synergies related to mergers and other business combinations, acquisitions, investments, dispositions, divestitures, restructurings, operating improvements, cost savings initiatives and other similar transactions or initiatives that are reasonably identifiable [and factually supportable] and projected by Holdings or the Borrower in good faith to result from actions that have been taken or with respect to which substantial steps have been taken (in each case, including any steps or actions taken in whole or in part prior to the Closing Date or the applicable consummation date of such transaction, initiative or event) or are expected to be taken (in the good faith determination of Holdings or the Borrower) within [36] months after any such transaction, initiative or event is consummated, net the amount of actual benefits realized during such period from such actions, in each case, calculated on a pro forma basis as though such cost savings, operating expense reductions and synergies had been realized on the first day of such period and for the entire period for which Consolidated EBITDA is being determined[; provided further that the aggregate amount added to or included in Consolidated Adjusted EBITDA pursuant to this clause (y) shall not, for any Test Period, exceed an amount equal to [ ]% of Consolidated Adjusted EBITDA for such Test Period, calculated after giving effect to any such addbacks or inclusion.] Source: representative precedent formulation |
At a very high level, the run rate cost savings / synergies addback allows the borrower to adjust EBITDA to reflect the lower annual cost (and therefore higher EBITDA) that will result from certain transactions or initiatives undertaken by the borrower. A common example is workforce reduction. The sponsor may be able to identify more efficient processes that will enable it to reduce headcount and therefore workforce expense. Or it may enter an acquisition which will allow it to reduce headcount by eliminating duplicative administrative functions. If the borrower is calculating EBITDA for a four-quarter period and the workforce reduction occurred in the fourth quarter, this add back allows the borrower to determine EBITDA as if the workforce reductions had occurred, and cost savings had begun accruing, at the beginning of the four fiscal quarter period, even though the cost savings only in fact began in the fourth quarter. You can imagine similar examples for things like closing duplicative factories following an acquisition or rationalizing supply chain expenses.
But the language goes further. Even if the cost savings did not begin in the fourth quarter – for example, the borrower has determined that in the next 18 months it will reduce workforce by a certain amount and generate certain annual cost savings – the borrower can adjust EBITDA for the current period as if those workforce reductions (and related cost savings) had occurred at the beginning of the current four fiscal quarter period. From the sponsor’s perspective this only makes sense – EBITDA is intended to be a measure of the ongoing ordinary cash flow of the business, and so should reflect cost reductions even if they have not yet been realized. These things take time. From the arrangers’ perspective, these adjustments can be speculative – what if the workforce reduction never actually happens (you will notice there is no reversal mechanism in the language above in that event). The issues from the arrangers’ perspective are most acute for “cost saving initiative” type adjustments that are not connected to a particular transaction (e.g., an acquisition). Those are viewed as more speculative and less susceptible to objective verification, and therefore resisted more strongly.
One note on the difference between strategic and private equity transactions. One of the reasons strategic buyers often have an advantage over private equity buyers is the synergies that can be derived from the acquisition. If you have an existing business and are looking to acquire a new business, you can drive synergies by eliminating overlapping functions, rationalizing and consolidating supply chains, bulk buying programs, combining factories where there is excess capacity etc. A private equity buyer (unless purchasing through another portfolio company) may have fewer options – it can bring the private equity firm’s expertise to bear on streamlining operations, but it has fewer obvious synergy plays. That means that the strategic buyer can often pay a higher price to acquire the target - the value of the target is greater to it than it is to the private equity firm because of the efficiencies it can drive in the combined businesses.
What does “run rate” mean?
“Run rate” refers to the extrapolation of financial results into future periods based on assumption that current conditions and results will continue. E.g., if you expect as a result of your reduction-in-force (RIF) program to generate $1.5M of cost savings per quarter starting in 12 months, then run rate cost saving for current test period would be 4 x $1.5M. Some language can be confusing. Some formulations state that you must give pro forma effect to cost saving initiatives/transactions as if it occurred on the first day of the period and adds back the “full benefit” of those initiatives/transactions as if they occurred on the first day of the period. This does not mean that if you expect aggregate cost savings to be $100M over 10 years, you get to add $100M back in the current test period. It is a different way of expressing the “run rate” cost saving.
What does “net of benefits received” mean?
Although not really a negotiated or controversial point, this is an important item to check for as it avoids a theoretical double count. Put simply, the borrower cannot get the actual benefit of cost reductions (e.g., lower employee costs increases CNI and EBITDA) while at the same time also adding back such costs (which would increase CNI and EBITDA again for the same cost savings. There is a good argument that this double counting would not be permitted in any case, but it is customary to make that clear.
Key points of negotiation
The speculative nature of this addback is one reason arrangers tend to be focused on negotiating certain parameters:
- The trigger: there are various ways that the events or transactions that trigger the right to adjust EBITDA can be formulated. You might see formulations that limit EBITDA adjustments to the expected impact of actions that have actually been taken, or for which substantial steps have actually been taken, within the test period. However, the most common formulation in BSL transactions is the one in the sample above – the trigger is that actions are “expected to be taken” at some point in the future. That creates significant flexibility and discretion in the hands of the borrower.
- Time period: it is common in BSL transactions for the look-forward period to be limited to 24-36 months (although some more aggressive forms start with no time limit), with flex to some shorter period (e.g., 18 months). The look forward period governs the period over which either the cost savings are expected to be realized (a conservative formulation) or over which actions are expected to be taken (i.e, we expect to take action in 18 months, and we can take the benefit of those actions even if the cost savings would not actually kick in for 5 years). The latter is the more common formulation in BSL transactions and is the one reflected in the example above.
- Qualitative control: historically the benefits “expected to be realized” from contemplated actions had to be “reasonably identifiable” and “factually supportable”. “Reasonable identifiable” is a loose standard but does suggest some minimal level of objectivity. “Factually supportable” is a term used in Regulation S-X and in general requires the adjustment to be the quantifiable outcome of identified actions. Although it’s a facts and circumstances analysis, it may require, for example, that an expected new contract is already in place, or that the borrower has identified the personnel to be terminated. The “factually supportable” standard is less common in BSL transactions as it suggests a level of certainty about actions taken that from the borrower’s perspective undermines the flexibility inherent in the forward looking nature of this addback - how do you provide “factual support” for the benefits of an action that you expect to take in 3 years?
- Certification/verification: although relatively uncommon in most of the BSL transactions, some sort of officer certificate is sometimes required before an EBITDA addback of this type is permitted. That is thought to give lenders some comfort on the basis that officers may be reluctant to certify overly aggressive addbacks.
- Cap: this is perhaps the item that attracts the most attention - see next heading.
Capping the addback
This is the most common protection that the arrangers insist on. It is typically included through flex in syndicated transactions and provides that the aggregate amount of the addback in any test period cannot exceed an agreed percentage of EBITDA - often to 25-30%. Although the percentage itself tends to be the focus, there are several important components to bear in mind:
- Cap Calculated before or after giving effect to the addback? The more conservative approach to calculating the cost saving addback (from the lender’s perspective) is to calculate the cap BEFORE giving effect to the cost saving addback itself. So if you have $100M of current EBITDA and the sponsor believes it will generate cost savings of $30M per annum starting in 12 months, and has a 25% cap on the cost saving addbacks which is determined BEFORE giving effect to the cost saving addback, the cap is simply 25% * $100M = $25M and EBITDA as defined would be $125M. The sponsor in that case is not able to add back the full $30M of anticipated cost savings by virtue of the $25M cap. However, typically in BSL transactions, the cap is calculated AFTER giving effect to the cost saving addback (which remember is itself capped in our example). That sounds a bit circular but the cleanest way to determine the cap in that case is to first calculate the maximum possible EBITDA giving effect to permitted adjustments (including caps). So in this example, that maximum adjusted EBITDA number would be $100M / (1.00-0.25) = $133.33M. Stated differently, current EBITDA ($100M) must be at least 75% of total EBITDA (since the synergy addback is capped at 25% of total EBITDA), so total EBITDA (including the synergy addback) cannot exceed $133.33M. From there you can calculate the cost saving adjustment cap as 0.25% * 133.33M = $33.33M. In this example, the cap does not actually limit the addback because the cap ($33.33M) is greater than the projected cost savings of ($30M). So the sponsor could add back the full amount of the cost savings to get to EBITDA of $100 + $30 = $130M. If the projected cost savings had been $50M, then the cap ($33.33M) is lower than the projected cost savings ($50M). In that case, the sponsor could not add back the full amount of the cost savings – it could only add back $33.33M of the cost savings and would get to EBITDA of $133.33M.
- Application of the cap. Note that in the example above, the cap only applies to clause (y) – meaning that there is NO CAP on addbacks relating to the transactions. Even though not immediately obvious from the sample language above, the cap will also not apply to any OTHER addbacks that may be listed in the EBITDA definition, but which may nevertheless include cost saving addbacks. The three most common examples, each expanded on in the pages that follow:
- Addbacks permitted under Regulation S-X
- Addbacks (of a type) set forth in the projections/sponsor model/CIM
- Addbacks set forth in QofEs
Restructuring/optimization costs addback
Most credit agreements have a separate addback along the lines set forth below, which also refers to “cost savings” and “expense reductions”. Do not be fooled! This is an entirely separate addback to those discussed in this section. This addback relates to the costs associated with cost saving initiatives, rather than the pro forma benefit of those initiatives. Unlike the cost savings addback, the restructuring/optimization costs addback IS usually subject to the limitation that you can only addback items that have reduced net income (i.e., it is a reversal of an actual cost of the company). Example: if you enter into a RIF program – this addback would deal with actual severance costs. Not the ongoing cost savings of having fewer employees.
Why should that be added back at all? Because it is viewed as not part of the ordinary operating expenses/costs of the company, but an unusual cost incurred to improve the business in some way. Because it is an actual cost, arrangers are less concerned about the addback, and it is typically not capped. The thing to watch is the long list of items that it often includes (the below example is a relatively short/conservative formulation). The list should be reviewed to ensure it doesn’t include items that should be capped. For example, it is common for sponsors to try to include in this list items that are also covered in other addbacks and capped, with the effect of providing an end-run around that cap (common examples may be software expenditures or pre-opening costs).
(xvi) costs, expenses, charges, accruals, reserves (including restructuring costs related to acquisitions prior to, on or after the Closing Date) or expenses attributable to the undertaking and/or the implementation of cost savings initiatives, operating expense reductions and other restructuring and integration and transition costs, costs associated with inventory category and distribution optimization programs, pre-opening, opening and other business optimization expenses (including software development costs), future lease commitments, consolidation, discontinuance and closing costs and expenses for locations and/or facilities, signing, retention and completion bonuses, costs related to entry and expansion into new markets (including consulting fees) and to modifications to pension and post-retirement employee benefit plans, system design, establishment and implementation costs and project start-up costs; Source: representative precedent formulation |
Interplay with other Pro Forma adjustments
As discussed above, when Pro Forma effect is given to Specified Transactions, the calculations may include cost savings and synergies relating to the Specified Transactions (calculated on a pro forma basis as though such cost savings and synergies had been realized on the first day of the period). Cost savings and synergies applied in this context should be subject to the same qualifications, limitations, and caps as the addback to EBITDA and should not be permitted in addition to the cost savings and synergies addback to EBITDA.