The spread of minibonds in Italy has represented a strategic junction in the development of the private debt market for unlisted SMEs. Introduced to facilitate diversification of financing sources, these bond instruments require careful structuring from a legal, financial and operational perspective, so that they can be attractive to professional and institutional investors. In this article we analyse three key aspects: covenants, guarantees and payment waterfall.
1. Covenants: contractual constraints and protections
Covenants represent a set of contractual obligations and restrictions included in the issuance agreement to protect investors. They are generally divided into:
Affirmative covenants
Commitments of the issuer to maintain certain behaviour, e.g:
- Maintain a minimum level of interest coverage ratio
- Provide detailed financial reporting on a regular basis
- Ensuring transparency on relevant events (incipient event of default)
Negative covenants
Limitations placed on the issuer's operations, such as:
- Prohibition of contracting new senior debt without consent
- Prohibition of dividend distributions above certain thresholds
- Restrictions on extraordinary transactions (mergers, divestitures, spin-offs)
Financial covenants
Quantitative indicators that the issuer undertakes to respect, such as:
- Maximum leverage (e.g. NFP/EBITDA ≤ 4x)
- Minimum DSCR (Debt Service Coverage Ratio ≥ 1.2x)
- Net assets ≥ predefined minimum threshold
Technical note: the negotiation of covenants is one of the main junctures in the structuring of a minibond. Their flexibility or rigidity directly impacts the rating (when present) and the interest required by investors.
2. Guarantees: risk mitigation instruments
Although minibonds are often unsecured (unsecured), the presence of collateral or personal guarantees can broaden the investor base and improve pricing.
Types of guarantees that can be used:
- Collateral: mortgage on real estate, pledge on shares or assets
- Personal guarantees: guarantees from shareholders, holding companies, or guarantee funds
- Public guarantees: Guarantee Fund for SMEs, interventions by CDP (Cassa Depositi e Prestiti), SACE or Confidi
Structured tools:
- Tranched cover: partial guarantee on junior or mezzanine tranches
- Guarantees on first demand: greater effectiveness for institutional investors
- Combined security package: collateral + personal guarantees for medium-risk issuers
3. Payment Waterfall: Priority in Cash Flow
The payment waterfall defines the order in which the cash flows generated by the issuer are distributed, in particular in the event of enforcement or liquidation. This pattern is crucial for instruments embedded in SPVs, baskets, or securitised portfolios.
Typical waterfall scheme:
- Legal and administrative expenses
- Servicer and Trustee Fees
- Senior Interest Payment
- Senior Capital Repayment
- Payment of subordinated interest (if any)
- Subordinated capital repayment
- Distribution to residual holders (equity)
Implications for the investor:
- The priority in the waterfall determines the actual risk level of the security
- Minibonds without explicit waterfall are more difficult to assess in terms of recovery in case of default
- In the presence of SPVs and multi-bond structures, waterfall becomes essential for credit analysis
Conclusion: structure is substance
It is important to emphasise that neither covenants, guarantees nor payment waterfall structures are mandatory in the structuring of a minibond. However, their introduction can bring significant benefits for both the issuer and the investors, depending on the profile of the transaction.
In many of the simpler transactions (single, unstructured minibonds), these elements are simplified or absent altogether. However, in more advanced transactions - typically aimed at professional investors - they represent credibility and transparency tools that directly affect the success of the issue.
The success of a minibond issue is not only about interest rates or duration, but above all about the quality of the contractual structure. Covenants, guarantees and waterfall are not regulatory requirements, but strategic options. A proper balance between sustainable covenants, credible guarantees and a clear waterfall is a decisive factor in attracting sophisticated investors and building a solid and transparent market. Including them (or being able to justify their absence) is an integral part of the structuring and advisory work that we at 2meet2biz.com offer our clients.