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Debt service coverage

Debt service coverage compares the cash a business generates with the loan repayments it must make. Lenders use it to judge whether an acquisition can carry its debt.

Also called DSCR, debt service coverage ratio

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Definition

Debt service coverage compares the cash a business generates with the loan repayments it must make, including both interest and capital. It is usually expressed as a ratio (DSCR): cash available for debt service divided by annual debt service. A ratio of 1.0 means the business earns exactly enough to meet its repayments, with nothing to spare. Lenders usually set a minimum ratio before they will lend.

Worked example

A fictional buyer is acquiring Crestview Auto Repair, a fictional US business with SDE of $500,000. A market salary for the owner's role is $100,000, which leaves $400,000 available to service debt. To keep the example simple, it ignores tax and capital spending.

The purchase is funded partly with a loan costing $250,000 a year in interest and capital repayments.

DSCR = $400,000 divided by $250,000 = 1.6 times.

If earnings fell by a quarter, to $300,000, coverage would drop to 1.2 times.

Seller's discretionary earnings (SDE)

Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.

Why buyers care

Coverage shows how much room the business has to absorb a bad year before you struggle to meet repayments. A deal that works on paper at the asking price can fail once you add debt and pay yourself a proper salary.

Test coverage on realistic earnings, not the seller's best year, and try a weaker case as well. In buyer mode, Loupe's valuation tool includes an affordability check: enter your deposit, seller finance, interest rate and loan term, and it shows the loan amount, annual debt service, coverage against a minimum threshold and a simple payback period. Lenders calculate coverage in their own ways, often after tax and capital spending, so confirm the method with yours.

Asking price

The asking price is the price a seller or broker puts on a business when it is listed. It is an opening position, not a valuation, and what it includes varies from listing to listing.

Seller finance

Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.

Related terms

  • Seller finance

    Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.

  • Senior debt

    Senior debt is borrowing that ranks first for repayment and is usually secured on the business's assets. It is typically the cheapest part of acquisition finance and carries the strictest conditions.

  • SBA 7(a) loan

    An SBA 7(a) loan is a US business loan made by an approved lender and partly guaranteed by the US Small Business Administration. It applies only in the United States and is widely used to buy small businesses.

  • Seller's discretionary earnings (SDE)

    Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.

  • Adjusted EBITDA

    Adjusted EBITDA is EBITDA after normalising adjustments, showing what a business would earn with a paid manager in the owner's seat. Larger small-business deals are usually priced on it.

  • Capital expenditure

    Capital expenditure is spending on assets that last more than a year, such as equipment, vehicles and premises. It uses cash but reaches the profit and loss account only gradually, through depreciation.

Guides

  • Financing an acquisition: deposits, lenders, seller finance and earn-outs

    Most business purchases combine the buyer's own money with a loan and often some deferred payment to the seller. This guide explains each layer, outlines government-backed lending by country and shows how lenders test whether a deal can carry its debt.

    11 minutes to read

  • How small businesses are valued

    Most small businesses are valued as a multiple of their earnings. This guide explains how the earnings basis is chosen, why size and quality move the multiple, and why an asking price is not a sale price.

    11 minutes to read

Red flags

  • Declining revenue or profit

    Falling sales or profit mean the business you take over is likely to earn less than its history suggests. Listings often price in the better years.

    Severity: price it inFinancials

  • Deferred maintenance or capital spend

    An owner who stops repairing and replacing equipment before a sale makes profit look higher and leaves you with the catch-up bill.

    Severity: price it inFinancials

Free tools

  • See a low, likely and high value from the figures you have, and whether the asking price holds up.

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