KKR and Stefano Pessina are considering using a controversial new type of financing to push through their £10 billion acquisition of Alliance Boots, the biggest European buyout to date.

The pair are talking to banks about so-called covenant-lite loans, which give them more legroom in the event that something goes wrong and they default on their repayments.

Covenant lite is a new concept in Europe, but the technique has been used often in America to help to fund the string of superdeals that have dominated the M&A market there in the past couple of years. Typically, private equity firms have to satisfy their lending banks with quarterly leverage tests, which assess the ratio of a company’s cashflow to its amount of outstanding debt and can, in some instances, restrict a company’s capital expenditure.

The ratios are important because they act as early warning signs of financial underperformance if sales decline, for example. Banks, in turn, are quick to act and demand that companies maintain performance at previously agreed levels or risk defaulting on their loans.

By contrast, covenant-lite loans are not tested quarterly and are typically far less restrictive than normal covenants. A lawyer at a top London firm, who advises private equity firms on financing, said: “From a borrower’s perspective, it gives you a lot more flexibility and manoeuvrability. Basically, the cushion is that much softer.”

Apax was the first British private equity firm to use covenant-lite loans, in its acquisition of Trader Media from the Guardian Group last month.

However, bankers said that it was unclear whether KKR and Mr Pessina would get the go-ahead to use the structure on such a huge and high-profile deal as the takeover of Alliance Boots.

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