A price is too high to finance when the debt the company can carry, plus the buyer's equity and whatever the seller will defer or roll, falls short of it. Lenders work backward from the company, not forward from the price. Senior cash-flow lenders commonly lend 2x to 3.5x EBITDA, and banks commonly look for debt service coverage of at least 1.25x; unitranche and mezzanine stretch further at a higher cost. Then lenders check the equity cushion and their own view of the company's value. Any gap has to come from equity or the seller, which is why the lender math belongs before the LOI.
- The binding question
- How much debt the company supports, not what it is worth to the buyer
- Leverage test
- Senior cash-flow lenders commonly 2x to 3.5x EBITDA; unitranche further
- Coverage test
- Banks commonly at least 1.25x on cash flow after capex and taxes
- Equity cushion
- Real equity beneath the debt; how much depends on the lender and the deal
- Value
- Lenders form their own view of enterprise value and lend well inside it
- After the LOI
- The levers left are more equity, more seller paper, junior debt or a lower price
The four tests a price has to pass
A buyer thinks about price as a multiple of EBITDA compared with other deals. A lender thinks about repayment: what happens to the loan if the next few years are worse than the last one. It runs four tests, and the price is too high the moment any one of them fails at the debt the buyer needs.
| Test | What it asks | Where the line commonly sits | What usually fails it |
|---|---|---|---|
| Leverage | How many years of EBITDA is the debt? | 2x to 3.5x EBITDA for senior cash-flow lenders; unitranche stretches further | A purchase multiple well above what senior debt can reach |
| Debt service coverage | Does cash flow pay the new principal and interest with a cushion? | At least 1.25x for conventional banks | Heavy amortization, or junior debt paying cash interest |
| Equity cushion | How much do the owners lose before the lenders do? | Set by each lender; thicker for first-time buyers and cyclical companies | A buyer who needs all the debt the company can carry and then some |
| Enterprise value | If the company had to be sold, would the debt be covered with room to spare? | Each lender's own view of value, from earnings and comparable deals | Earnings that do not support the multiple once add-backs are tested |
Leverage and coverage are two views of the same earnings. Which one binds depends on the loan's pricing and amortization: a unitranche with light amortization keeps payments low, so leverage binds first; a bank term loan that amortizes quickly raises payments, so coverage can bind even when leverage looks fine. Both are explained in how much debt a business can carry, with the definitions in debt service coverage ratio and senior leverage ratio.
Which earnings lenders test
Most disagreements about price are really disagreements about earnings. The seller's advisor presents one number; lenders build their own from the documents, and it is almost always lower.
- The latest full year, not an older one. Lenders size on the most recent full year of figures, with a year-to-date P&L to show the trend. A price set on a stronger earlier year will be tested against the weaker recent one. See financing an acquisition with declining earnings.
- Add-backs the lender accepts. Owner costs and one-time items are added back only when documented and truly gone after closing, usually as tested in a quality of earnings. See EBITDA add-backs.
- Market pay for whoever runs the company. If the seller was underpaid, or did several jobs, lenders deduct what it will cost to replace them.
- Capital spending and taxes. Equipment that has to be replaced and taxes that have to be paid come out of the cash available for debt service.
- Historical results, not projections. Lenders may give some credit to contracted revenue or savings already achieved, but rarely to a buyer's plan. See lending on run-rate EBITDA.
A worked example: where the price outruns the debt
Plain numbers. A company has adjusted EBITDA of 2,000 and, after maintenance capital spending and taxes, 1,500 a year available for debt service. A senior lender will lend three times EBITDA, 6,000, and at its pricing and amortization the payments on that come to 1,200 a year, exactly 1.25x coverage. The senior loan cannot grow without failing one test or the other.
The seller wants 12,000. The buyer has 3,000 of equity. With 6,000 of senior debt, the gap is 3,000, and no amount of negotiation with the senior lender closes it, because the lender did not choose the 6,000; the earnings did.
| Lever | What it does to the lenders' tests | The catch |
|---|---|---|
| Lower the price to 9,000 | Senior debt of 6,000 plus 3,000 of equity fits both tests | The seller has to agree, and after the LOI the buyer has less leverage to ask |
| More equity: 6,000 instead of 3,000 | Senior debt stays at 6,000; a thick cushion | The buyer or its investors need the cash, and own less of the return |
| Seller note of 1,500 that accrues, plus a rollover of 1,500 | No new cash payments, so coverage holds; the rollover adds equity beneath the loan | The seller waits for much of the price and shares the risk |
| Seller note of 3,000 paid currently | Its payments enter the coverage test, which was already at the limit | Does not work here: it just moves the shortfall |
| A unitranche instead of senior debt | Stretches further in one loan, with lighter amortization | A higher blended rate on the whole balance, and call protection |
| Mezzanine behind the senior loan | Fills part of the gap with PIK interest that needs no cash now | Cost, often warrants, and an intercreditor agreement |
| An earnout for part of the price | Paid only if the company performs, and subordinated to the loans | Lenders count it once it is likely to be earned, and block it on default |
Most real deals combine several levers: a modest price concession, a subordinated seller note with part of its interest accruing, a rollover, and a slightly larger equity check. The sources and uses is where the combination is tested line by line. Junior debt is covered in mezzanine debt and senior vs unitranche.
Lenders do not negotiate the debt up to the price. The earnings set the debt, and everything above it is the buyer's and seller's problem to solve.
What happens when the price is agreed first
When a buyer signs an LOI at a price the company cannot support, the lenders' answer comes back in one of three forms: terms at less debt than requested, terms conditioned on more equity, or a decline. Lenders rarely stretch their leverage or coverage limits because a buyer has already committed to a price.
At that point the only levers left are the ones in the table above. Each one moves money or risk onto the buyer or the seller. The price itself can be reopened, but a buyer who returns to the seller after the LOI is asking for a concession, not negotiating from a position of choice. Earnout mechanics are in earnouts and acquisition debt, and how much seller paper lenders tolerate is in how much seller financing.
Run the lender math before the LOI
Everything in the worked example can be done before an offer is made, from the documents a seller normally provides to a serious buyer:
- Rebuild EBITDA from the latest full year: accepted add-backs and market pay for the roles the seller filled.
- Size the senior debt on leverage, then check coverage on cash flow after capital spending and taxes.
- Add the equity you actually have committed.
- Decide what seller paper and rollover the seller would accept, and on what subordination terms.
- Decide whether a junior layer is worth its cost.
- The sum is the price the deal can finance. Offer on that, or know exactly which lever covers the difference.
Lenders or a debt advisor can give an early read on likely leverage, structure and deal-breakers before the LOI; see talking to lenders before the LOI. The LOI itself should carry a financing contingency. Midas Partners builds the financing model that runs these tests at the proposed price, as part of the full lender package, in a day once the documents are in; by hand it takes at least a week. See the package and how we underwrite.
When paying above the debt is a reasonable choice
A price above what lenders will fund is not always a mistake. A strategic buyer may expect savings or cross-selling the seller could never achieve, and an add-on may be worth more inside a platform than alone. Lenders generally will not lend against savings that have not happened yet, so that premium is paid with equity. That is a sound decision as long as the buyer knows it is making one and the debt is sized on the company as it stands. How lenders treat an acquisition into an existing company is in add-on acquisition financing, and lenders' more conservative view of value in how lenders value a business.
It also helps to know which lenders to ask. At this size the company has usually outgrown SBA, whose 7(a) loans go up to $5 million, and the field is banks, private credit funds, asset-based lenders and junior capital providers. Midas Partners's book holds 1,800+ lenders, 1,148 of which write term and private credit, and lenders differ widely in how far they will go on the same EBITDA.
Common questions
- Will lenders finance the price the seller's advisor asked for?
- Only if the company's EBITDA supports the debt that price requires. Lenders size debt from verified earnings, leverage and coverage, not from the asking price, so the answer is often less debt than the buyer expected.
- Does the purchase multiple matter to lenders?
- Indirectly. Lenders care about how many turns of EBITDA the debt represents, and senior cash-flow lenders commonly stop at 2x to 3.5x EBITDA. A high purchase multiple is fine if equity, seller paper and any junior debt cover the part above the senior loan.
- Can lenders count the growth I plan after buying the company?
- Rarely. Lenders size on historical results. Contracted revenue or savings already achieved may get some credit; a buyer's plan usually does not.
- Is a seller note enough to bridge a price the lender won't fund?
- Only if the company can carry its payments or the seller accepts deferring them. A seller note paid in cash adds to debt service, which is usually what was already binding. A note that accrues interest, or a rollover, avoids that.
- Will a unitranche lender finance more of the price?
- Usually more than a senior lender, in one loan at a higher blended rate. Whether it is worth it depends on the cost of the whole stack against the alternatives, including more equity or seller paper.