DSCR on $5-$10M deals and implications on growth rates

June 27, 2024

by a searcher from Dartmouth College - Tuck School of Business at Dartmouth in Boston Metropolitan Area, USA

Just read a great post from ^redacted‌ on financing deals in the $5-$10M ent value range.

I've been looking at deals in this range, and am surprised that banks are willing to go to a 1.25 DSCR. From my perspective, this much leverage removes any margin of safety. While I intend to grow the business I acquire, I am aware of the risks that revenue can drop in short term if key employee of customer leaves.

I feel more comfortable with###-###-#### DSCR. Or course once multiples get above 4.5X (with my equity plus sellers note getting into the 20-25% range with 70-75% bank financing at 10.5% - 11.0%) my cash flow model gets very tight, in the###-###-#### DSCR range

Are there any self funded searchers who think I am missing something? Or is the bottom line any deals above 4x adj EBIDTA simply require Year 1 growth?

Reply by a lender
from California State University, Sacramento in Seattle, WA, USA

1.50 dsc is music to my ears as people who know me and how we approach leverage have heard me talk about for years to beware over-leveraging. For industry agnostic deals. Especially for larger transactions where balancing the cap stack probably should involve higher levels of equity and seller notes to match larger ebitdas and multiples. For those industries where Live Oak has vertical expertise, lesser DSC thresholds might make sense to the bank. A first time buyer should think long and hard about acceptable leverage levels regardless of the bank opinion. All the comments preceding me in this post all resonate especially the comment on the j-curve. It’s real. Happy to talk 1:1. And our weekly office hours on structure and approach can be a good compliment to your search process. redacted ^redacted‌

Reply by a searcher
from The Johns Hopkins University in Houston, TX, USA

Thanks for starting an interesting discussion ^redacted‌. A DSCR of 1.25 would make me similarly anxious, even (or perhaps especially) beneath the $5 million to $10 million EV range you highlighted. I find smaller businesses that have been run "lean" are more likely to require early CapEx or OpEx increases just to maintain operations following the sale, with deferred maintenance and seller role replacement being two possible reasons why the historic EBITDA might exceed the cash flow actually available for debt service post close.

I recall ^redacted‌ and ^redacted‌ mentioning at last year's Self Funded Search conference that Live Oak might be considered by some to be relatively conservative with the DSCR they look for. I suppose it's my God given right as a red blooded American searcher to take on as much leverage as I can, but honestly I think a 25 percentage point increase DSCR would improve my sleep quality by 100% or more.

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