Debt capacity

Debt capacity is the maximum amount of debt a company can raise and repay without jeopardising its operations or breaching its financial commitments. It depends not only on the size of the balance sheet, but on the regularity and predictability of cash flows, the intensity of CAPEX (capital expenditure) and the sensitivity of the activity to economic cycles.

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Its estimation rests on prudential ratios tracked by lenders: the Leverage ratio (net debt / EBITDA), the DSCR – Debt Service Coverage Ratio and the Interest Coverage Ratio (ICR). These thresholds set, for a given level of earnings, the debt compatible with sustainable service. The more stable and recurring the flows, the higher the debt capacity, at comparable profitability.

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Concretely, with 5 MCHF of EBITDA and a maximum leverage of 3.5 times accepted by lenders, debt capacity works out at around 17.5 MCHF. On an acquisition price of 25 MCHF, 7.5 MCHF would then remain to be funded with equity.

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Debt capacity is the starting point for sizing a Leveraged Buy-Out (LBO): it determines the share of the price financeable with debt, and hence the equity contribution required. In financial structuring, calibrating it realistically avoids weakening the target with excessive leverage, a frequent cause of post-deal strain.