A bank does not need a warehouse full of equipment to lend against an acquisition. It needs a cash-flow story it believes, tested against a coverage ratio, built on numbers it has reason to trust.
Key takeaways
Asset-based lending sizes a loan against what a lender can seize and sell. Cash-flow lending asks a different question: will this business, run as it is, generate enough cash after operating costs to make the loan payment, quarter after quarter, without a piece of collateral standing behind it as the fallback. It is the more common underwriting basis for a service business, a professional practice, or anything else where the value is genuinely in the earnings rather than in machinery.
Deavo’s published capital-stack bands name the specific coverage ratio banks size a cash-flow loan against: “≥ 1.25× on SDE” for deals in the roughly $200,000–$1 million range, and “≥ 1.30× on EBITDA” once a deal moves into the $1 million–$5 million band, with a slightly wider “~1.2–1.5×” range at the mid-market end. (deavo.ai/financing) Debt service coverage, in plain terms, is a measure of whether the target’s normalized cash flow covers the proposed loan payments with room to spare — a ratio of 1.30× means the business would need to lose roughly a quarter of its earnings before the coverage test fails outright. A bank sizing a cash-flow loan is solving backward from that ratio: given the earnings it believes, what loan payment — and therefore what loan amount — still clears the target coverage.
Because there is no collateral pool doing the heavy lifting, the credibility of the earnings number carries almost the entire lending decision. Deavo’s own guidance on reading financials before a purchase lists the standard red flags a bank’s underwriter will look for: owner compensation, benefits and personal expenses run through the business; one-time items “such as a lawsuit settlement or a one-off equipment sale”; related-party or non-arm’s-length pricing, “including rent paid to a property the owner also owns”; and a gap between what the statements show and what was actually filed with CRA or for GST/HST. (deavo.ai/insights/reading-financial-statements-before-you-buy) Every one of those items, if unresolved, either overstates the cash flow the bank is being asked to lend against or raises doubt about the reliability of everything else in the file.
A bank reading SDE — seller’s discretionary earnings — is looking at cash flow available to a single owner-operator, add-backs and all. A bank reading EBITDA is assuming the business already pays, or would need to pay, a market wage to whoever runs it. Deavo’s own editorial is explicit that “there is no fixed revenue or profit threshold at which a business switches from being discussed in SDE terms to EBITDA terms” — it is a judgment call keyed to whether a functioning management team stays on after closing, not a rule a buyer can look up. (deavo.ai/insights/sde-vs-ebitda-which-valuation-method-fits-your-deal) The same source calls aggressive or unsupported add-backs “one of the more common points of pushback during due diligence” — precisely because inflating either earnings measure inflates the coverage ratio a bank is testing against, and a lender that catches it stops trusting the rest of the file, not just the disputed line item.
Cash-flow lending does not mean a bank ignores the balance sheet entirely. Deavo’s own diligence checklist lists AR/AP aging and “outstanding loans, leases or liens against assets” as standard financial due-diligence items alongside the earnings review. (deavo.ai/insights/due-diligence-checklist-first-time-buyers) A cash-flow lender wants to know that the receivables behind the projected cash flow are actually collectible on schedule, and that no existing lien on the target’s assets would complicate the bank’s own security position after closing — the loan may be sized off earnings rather than collateral value, but the collateral picture still informs how comfortable the bank is with the file overall.
It is worth keeping two different multiples apart. The coverage ratio a bank tests — 1.25–1.30× — is a lending decision about how large a loan the cash flow can service. Deavo’s separate pricing-context figures — earnings multiples “often ~2–3×” on SDE for smaller deals and “~3–5×” on EBITDA for larger ones, with enterprise value “typically ~6–8× EBITDA” at the mid-market end — describe how the purchase price itself gets set. (deavo.ai/financing) A bank lending against cash flow is not pricing the business; it is asking whether the earnings, whatever multiple the buyer and seller agreed to pay for them, can service the specific loan amount being requested. A deal priced fairly by market convention can still fail a bank’s coverage test if too much of the price is being financed with debt relative to the earnings behind it.
A buyer is purchasing a bookkeeping and payroll-services firm for $2,200,000, with normalized EBITDA of $520,000 after the buyer’s accountant strips out $60,000 of owner perks and a one-time $35,000 legal settlement the seller had booked as an operating expense the prior year. Structuring the senior tranche at the small-band 55% — $1,210,000 — against a bank’s 1.30× EBITDA coverage target implies the bank wants to see roughly $400,000 of debt-service capacity ($520,000 ÷ 1.30) before it will approve that amount. Because the adjusted EBITDA of $520,000 clears that bar with room to spare, the bank proceeds on the cash-flow basis alone; had the seller’s original, unadjusted figure of $615,000 been taken at face value without stripping the perks and the settlement, the same coverage math would have implied a loan the business could not actually service once those items were removed.
Related: preparing a lender package a bank will approve, the glossary entry on cash-flow lending, and financial projections lenders find credible.
Debt service coverage ratio measures normalized cash flow against the proposed loan payment. A bank solves backward from its own target ratio — roughly 1.25× to 1.30× on deavo’s published bands — to the maximum loan the business can actually service, independent of what the buyer and seller agreed as a price.
Cash-flow lending reduces reliance on collateral but rarely eliminates it entirely — a bank will typically still take a general security interest and, on an acquisition loan, expect a personal guarantee from the buyer alongside the cash-flow test.
The bank makes the call, and deavo’s own editorial confirms there is no published threshold governing it — the practical driver is whether a management team beyond the owner stays on after closing.
A short call is enough to stress-test normalized earnings against a realistic DSCR before you approach a lender.
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