The debt service coverage ratio (DSCR) is cash flow available for debt service divided by the total principal and interest due in the period — whether the business’s cash flow comfortably covers its loan payments.
DSCR is the headline financial covenant in an acquisition loan agreement, tested periodically (often quarterly or annually) rather than tested once at closing and forgotten. A single quarter of thin cash flow can put a borrower offside even if the business is otherwise performing.
Market-facing bands exist but come with an explicit health warning attached every time they are quoted: “illustrative estimate only — not a financing offer, pre-approval, or financial, legal or investment advice”. For a Canadian small-business acquisition the figures circulating are at least 1.25 times SDE for smaller, SDE-based deals, at least 1.30 times EBITDA once underwriting has moved to EBITDA, and roughly 1.2 to 1.5 times EBITDA for mid-market transactions — and none of the three claims to be a rule any specific lender must follow.
The consequence of falling short is not a warning letter. the loan agreement typically defines the breach as an event of default, and once triggered a lender can typically demand repayment of the full loan or move to enforce security under whatever general security agreement the loan agreement grants it.
Cash flow available for debt service in the trailing year is $520,000. Existing principal and interest obligations on the acquisition loan total $400,000 for the same period. DSCR works out to $520,000 divided by $400,000, or 1.30 times — exactly at the illustrative small-deal EBITDA-based band above, with no cushion: a single soft quarter would put the covenant offside, which is exactly why a lender negotiating this file would likely want to see room above 1.30 times, not sitting on the line.
See also: financial covenant, cash-flow lending and leverage multiple.
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