Prospective financial buyers are bidding high multiples, but their offers assume high bank leverage. How do we calculate our business's true debt capacity so we do not accept a letter of intent that collapses during bank underwriting?

Question

Tyler Smith · Accepted Answer

Many deals fall apart between the letter of intent and closing because the buyer promises a valuation multiple that commercial lenders will not finance. Financial buyers and independent sponsors often submit inflated bids, assuming they can fund seventy percent of the transaction with low-interest bank debt. When senior lenders review the file and restrict leverage, the buyer comes back with an aggressive re-trade or walks away entirely.

To protect your time and company valuation, calculate your business's debt service capacity before entering negotiations. Commercial banks underwriting lower-middle-market acquisitions typically limit senior cash-flow debt to three to four times trailing twelve-month adjusted EBITDA. Furthermore, lenders require a debt service coverage ratio of at least 1.25 to 1.5 times, meaning operating cash flow must easily service principal and interest payments under current borrowing rates.

If a buyer bids an eight-times EBITDA multiple, senior bank debt will realistically cover only three to four turns. The remaining four to five turns must come from sponsor equity, subordinated mezzanine debt, or a seller note. If the buyer's source of funds relies on uncommitted financing or excessive leverage without committed equity backstops, the deal structure is fragile.

Require every bidding group to submit proof of equity funds and commercial bank term sheets alongside their initial offer. During the due diligence phase, track financing contingencies as a critical Rock on your transition dashboard. If a buyer cannot demonstrate lender commitment within thirty days of signing the letter of intent, exercise your right to terminate negotiations before operational disruption sets in.