Debt service coverage ratio (DSCR) is a key metric when buying or selling a business, especially for buyers looking for acquisition financing. Both lenders and buyers use this financial ratio to assess whether a company’s income can adequately cover its current and future debt payments, including new acquisition loans. In this article, we’ll explain what DSCR is, why it matters in business transactions and financing, and how it impacts both business valuations and loan approvals.
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Key Stakeholders Who Use DSCR
- Buyers: Buyers rely on DSCR during due diligence to understand the business’s financial stability and ability to support acquisitions debt
- Sellers: By tracking and improving their DSCR, sellers can increase their business’s value and make it more financeable for potential buyers
- Valuators: People who assess a business’s worth use DSCR as a key metric to determine a company’s worth and debt capacity
- Lenders: Banks or financial institutions use DSCR to assess whether the buyer can handle both the acquisition debt and existing business obligations
DSCR = Annual EBITDA / Total Annual Debt Payment
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What Makes a Good DSCR
Understanding what constitutes a “good” DSCR is important when buying or selling a business. While any ratio above 1.0 technically shows the business can cover its debt payments, most lenders and buyers look for stronger coverage. A DSCR of 1.25 is typically considered a strong benchmark, meaning the company generates $1.25 in income for every $1 in debt payments. Conversely, ratios below 1.0 indicate the business might struggle to meet its obligations.
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DSCR in Loan Applications
When applying for acquisition financing, lenders focus heavily on DSCR as a key indicator of repayment ability. Most traditional lenders look for a minimum DSCR of 1.25, though some loan types may accept ratios as low as 1.15 depending on other business factors and industry standards.
To evaluate your loan application, lenders typically require:
- Income statements
- Cash flow projections
- Debt schedules
- Supporting documentation for any DSCR adjustments
If your DSCR falls below lender requirements, don’t give up immediately. Be prepared to explain any temporary factors affecting the ratio, such as one-time expenses or seasonal fluctuations. You may also strengthen your application by providing additional financial metrics like cash flow forecasts, liquidity ratios, or strong credit history. Some lenders may be willing to work with lower DSCRs if you can demonstrate strong business fundamentals and a clear plan for improvement.
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Source: https://www.bizbuysell.com/learning-center/article/debt-service-coverage-ratio/?utm_source=bizbuysell&utm_medium=email&utm_campaign=brokerb120125