Often, but only at a debt level that reflects where earnings are heading. Lenders weight the trailing twelve months and the latest months more than older years, and size leverage on the lower, current EBITDA unless there is evidence the decline has stopped. They accept explanations the monthly figures prove, such as a one-time loss, a deliberate exit from unprofitable customers or a recovery already under way. The gap to the price is usually closed by a price reset, more equity, a larger seller note or rollover, or an earnout that pays only if earnings recover.
- What lenders size on
- Trailing twelve months and the latest monthly trend, not the best year
- Common senior reach
- Senior cash-flow lenders commonly lend 2x to 3.5x EBITDA, on the current figure
- Explanations that work
- Ones the monthly figures prove: a one-time loss, a deliberate customer exit, a recovery under way
- Bridging the gap
- Price reset, seller note or rollover, more equity, an earnout
- What stops the deal
- A decline still running in the latest months
Which earnings lenders use
A lender looking at an acquisition reads three years of results and the current year to date, and builds the trailing twelve months, or TTM, from them. When earnings are steady or rising, the choice of period barely matters. When they are falling, it decides the financing. Lenders do not average a falling series to lift it, and they do not use the year the price was based on. They use the most recent twelve months, and then ask whether the most recent months within that are lower still.
Both tests move with the lower figure. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA, and a falling trend pushes a lender toward the bottom of its range as well as shrinking the EBITDA it applies the range to. Conventional bank lenders commonly look for debt service coverage of at least 1.25x, measured on the same recent figures, and they set covenants with the trend in mind, so a company that is still sliding can breach them in the first year.
The figures must also be current. Lenders want the target's latest full year, never an older one because it looked better, and a year-to-date P&L through the last month-end. A file that leads with a stronger prior year reads as an attempt to hide the trend, and it is the trend lenders will ask about first.
| Pattern in the figures | How lenders usually read it |
|---|---|
| Falling across three years and still falling this year | Sized on the latest months, or declined; the buyer is being asked to finance a turnaround with cash-flow debt |
| One weak year, with recent months back near earlier levels | TTM with the recovery shown month by month; credit for the recovery depends on how long it has held |
| A drop in the latest year, flat since | Sized on TTM; the flat months are the argument that the decline has stopped |
| Revenue down, margins up | Consistent with dropping unprofitable customers, if customer-level figures show it |
| Revenue up, margins down | A pricing or cost question: have prices caught up with labor and materials costs yet? |
| Add-backs growing as earnings fall | Skepticism; lenders test every add-back and lean hard on the quality of earnings |
Explanations lenders accept, and what each needs
Every seller of a declining company has an explanation. Lenders hear the same few, and each one lives or dies on a particular kind of evidence.
| Explanation | Evidence that carries it | What undermines it |
|---|---|---|
| A one-time loss: a lawsuit, an uninsured claim, a bad debt, a failed project | Documents for the event, and ledger detail showing it does not recur | A different one-time item in each of the last three years |
| A deliberate exit from unprofitable customers or lines | Revenue and gross margin by customer, before and after; remaining customers steady or growing | Good customers leaving at the same time |
| An owner who stopped pushing the business | Falling sales activity with steady retention; a pipeline that dried up rather than customers who left | Hard to prove, and relies on the buyer's effort; lenders give credit only once results turn |
| A cost spike: labor, materials, insurance | Price increases already put through and holding in recent months | Price increases that are planned, not made |
| A lost major customer | None; this is not an explanation but a new baseline | Nothing to undermine; lenders size without that customer |
| An industry-wide downturn | Comparable companies affected the same way, and signs of the cycle turning | A company falling while its market recovers |
Add-backs deserve particular care in a declining company. A seller whose adjusted EBITDA holds steady while reported EBITDA falls is often adding back more each year. Lenders test each one, as described in EBITDA add-backs, and a rising total is a reason for them to look harder, not a reason to lend more. The owner who stopped pushing the business is common in sales by retiring owners; see buying a company from a retiring owner.
Evidence that the decline has stopped
The explanation says why earnings fell. What gets debt committed is evidence they have stopped falling. That evidence is monthly, not annual.
- Monthly P&Ls side by side for the current and prior years, so each month compares with the same month a year earlier and seasonality does not disguise the trend.
- Revenue and margin by customer, showing which customers drove the decline and that the rest are holding.
- Forward indicators: backlog, bookings, signed contracts, renewal rates, whatever the company has that shows next quarter before it happens.
- Proof of any actions taken: the price increase in the invoices, the cost cut in the payroll, the replacement sales leader on the payroll and producing.
A quality of earnings report will test all of it. A declining company is exactly where that work earns its cost, and a buyer who commissions it early learns the real baseline before the price is fixed. Where recent months are genuinely stronger, some lenders will give weight to a run-rate figure, within limits described in lending on run-rate EBITDA.
Lenders size to where earnings are going. A story explains the decline; only the latest months can show it has stopped.
How big the gap is
A worked example in plain numbers. A company earned EBITDA of 2,800 three years ago, 2,500 last year and 2,100 over the trailing twelve months, and the latest months are running at about the same pace. The buyer and seller agreed a price based on last year's 2,500. A senior lender willing to lend three times EBITDA on a stable company will lend on the current figure.
| Basis | EBITDA | Senior debt at three times EBITDA |
|---|---|---|
| Last year, which the price was based on | 2,500 | 7,500 |
| Trailing twelve months, which lenders use | 2,100 | 6,300 |
| Difference | 400 | 1,200 |
That assumes the lender is satisfied the decline has stopped at 2,100 and keeps the same multiple. If the latest months are lower still, it will size lower again, and a lender worried about the trend may also move down its range. The whole difference has to come from somewhere other than the senior loan. The sizing method is in how much debt a business can carry.
Structures that bridge the gap
| Structure | How it closes the gap | What lenders will want |
|---|---|---|
| Price reset | The price comes down to what current earnings support | Nothing more; the cleanest answer where the decline is real |
| Earnout | Part of the price is paid only if EBITDA recovers to an agreed level | Subordinated, blocked on default, and counted once it is likely to be earned |
| Larger seller note | The seller finances more of the price and shares the risk | Subordinated, with cash payments limited so coverage holds on current earnings |
| Seller rollover | The seller keeps a stake and shares in any recovery | No put or redemption before the loan is repaid |
| More equity | The buyer or sponsor funds the difference | Welcomed; lower leverage gives covenants more room |
| Seller transition | The seller stays on to steady customers | A written role and term, with key relationships handed over |
The earnout is the structure built for this situation: the buyer pays for the recovery only if it happens. Earnouts and seller notes are compared in earnout versus seller note and covered in earnouts and acquisition debt. How much seller financing lenders will accept is in how much seller financing.
Where the decline is still running, cash-flow lenders will usually decline, and a buyer should be wary of a deal that needs one. Some asset-based lenders lend against receivables and inventory with less weight on earnings, as described in asset-based lending for unprofitable companies, but that finances working capital, not a price built on better years.
Presenting a declining company to lenders
The worst way to present a decline is to let lenders find it. A file that leads with the trend, gives the explanation with its evidence, shows the monthly figures that prove it has stopped, and sizes the debt on the current baseline gets read as an honest credit. One that leads with the best year gets read as a sales document, and lenders discount everything in it.
Midas Partners does not take a file to lenders on older-year figures or incomplete ones. The financing model is built on the latest full year and the year to date, with the monthly trend laid out, and the underwriting memo states the decline and the evidence on the first page. Once the documents are in, the package is built in a day and a senior banker checks every page. The book of 1,800+ lenders includes lenders comfortable with a company that has had a bad year and recovered, and they see a blind teaser before the client approves each one by name. Why acquisition financing gets declined is in why acquisition loans get declined, and what goes in the package in the lender package.
Common questions
- Will lenders use the better prior year if this year was a one-off?
- Not directly. Lenders size on the trailing twelve months. If a one-time loss caused the dip and can be documented, lenders may add it back to the recent figures, which brings the result closer to the earlier year, but they will not simply substitute the older year.
- Can an earnout bridge the gap?
- Often, yes. An earnout that pays only if EBITDA recovers puts the price of the recovery where the risk is. Lenders will want it subordinated, blocked on default, and sized so that paying it does not breach their covenants.
- How much recovery do lenders need to see?
- There is no fixed number of months. Lenders want enough monthly results, compared with the same months a year earlier, to be confident the trend has turned rather than paused. The more seasonal the company, the more of the year they want to see.
- Will a quality of earnings report help?
- It helps when the decline has a real, documentable cause, because it gives lenders an independent baseline and tests the add-backs that tend to grow as earnings fall.
- Should I renegotiate the price?
- If the price was set on a year the company no longer earns, usually yes. Lenders will size on current EBITDA, so the gap has to be closed somehow, and a price reset or an earnout is often the cleanest way.