DSCR: How Lenders Decide If Your Deal Works
DSCR stands for Debt Service Coverage Ratio. It's the single most important number in lender underwriting for a business acquisition — a simple ratio that tells a lender whether the business generates enough cash to pay back the debt used to buy it.
Every lender who finances a business acquisition runs this calculation. If your DSCR comes in too low, the deal doesn't get funded — regardless of everything else.
The Formula
DSCR = Net Operating Income ÷ Total Annual Debt Service
Net operating income (for SBA lenders) = SDE minus a market-rate replacement manager salary, minus taxes
Total annual debt service = all loan payments: SBA loan P&I + seller note payments + any other debt
A DSCR of 1.0× means the business earns exactly enough to cover its debt. A DSCR of 1.25× means the business earns 25% more than required — the standard SBA minimum. Most lenders prefer 1.35× or higher to have a comfort buffer.
Example: Calculating DSCR on a $700K Acquisition
Business SDE: $180,000
Management salary replacement: $60,000
Estimated taxes: $15,000
Net operating income: $105,000
SBA loan: $560,000 at 10% over 10 years → monthly payment ~$7,400 → annual: $88,800
Seller note: $70,000 on standby (no payments in year 1)
Total debt service (year 1): $88,800
DSCR = $105,000 ÷ $88,800 = 1.18×
This deal would likely be declined at most SBA lenders (below 1.25×). To fix it: reduce the loan amount (larger down payment), negotiate a lower price, or require a longer loan term.
What Counts as Debt Service
Lenders include all annual loan payments — principal and interest combined. For an acquisition, that includes:
- The SBA 7(a) loan P&I payment
- Any seller note payments (if not on standby)
- Earnout payments if structured as guaranteed minimums
- Any existing debt the business is carrying post-close
The Manager Salary Haircut
Lenders don't count the full SDE as available for debt service. They subtract what a market-rate hired manager would cost to run the business, since not every buyer will operate the business full-time forever. This haircut varies by business type but is often $50,000–$90,000. It's the most common source of confusion when buyers calculate DSCR themselves and get a higher number than the lender does.
How to Improve DSCR
- Increase down payment — reduces the SBA loan amount and thus annual debt service
- Negotiate a lower purchase price — reduces the total financed amount
- Structure seller note on standby — defers seller note payments, reducing year-1 debt service
- Extend loan term — 10 years vs. 7 years reduces annual P&I payments significantly
Model these variables in the AcquireCalc deal calculator before approaching lenders to understand your DSCR before anyone else does.
Related Terms
- SBA 7(a) loan — the primary loan whose payments go into debt service
- Seller financing — structuring seller note on standby affects DSCR calculation
- Deal stack — the full picture of financing that determines debt service
Sources & Further Reading
- SBA SOP 50 10 — official DSCR calculation methodology used by SBA lenders