DSCR: the number that decides what you can actually pay

The definition

Debt-service coverage ratio is earnings divided by annual loan payments.

DSCR = SDE ÷ Annual debt service

A DSCR of 1.0 means the business produces exactly enough to make the payments and nothing else. A DSCR of 1.5 means it produces half as much again.

Most SBA lenders want 1.25× or better, computed on earnings they can verify — which is rarely the earnings on the listing.

The subtlety that catches people out

Lenders do not use SDE as advertised. They make two adjustments, and both of them matter:

They deduct a salary for you. You have to eat. A lender typically assumes $50,000–$75,000 of owner compensation before the loan is serviced, because a buyer who cannot pay themselves will eventually stop paying the bank.

They discount unverifiable add-backs. If a $36,000 consulting fee has no agreement behind it, most underwriters will not credit it.

So the calculation is really:

DSCR = Documented SDE - Your salary ÷ Annual debt service

Working it backwards

This is the useful direction, and almost nobody does it.

Start with documented SDE of $174,200. Deduct a $60,000 salary — $114,200 remains. Divide by the 1.25× coverage requirement: the business can support about $91,360 of annual debt service.

Now invert an amortisation schedule. At 10.75% over ten years, $91,360 a year services roughly $672,000 of principal... except SBA acquisition loans for a business without real estate typically run ten years, and the buyer contributes 10–15% equity. Work through it properly at those terms and the supportable price lands near $438,000.

If the asking price is $525,000, that gap of $87,000 is not a negotiating position. It is a constraint imposed by a third party who looked at the same numbers.

Why this is the strongest thing you can bring to a negotiation

Every other argument you make is your opinion against the seller's. Comparable multiples are contestable. Your view of the competition is contestable. Your assessment of the lease is contestable.

A lender's term sheet is not.

"We would like to pay more. Our lender will underwrite to $438,000 on the documented earnings. Here is the letter." That is a different conversation from "we think it is worth less."

The three ways the gap gets closed

More equity. You put in the difference. Understand that you are funding the portion of the price a bank declined to fund, and price your own risk accordingly.

A seller note. The seller finances the gap, usually subordinated to the bank debt. This is the cleanest solution and it is also a test: a seller who believes their own numbers should be comfortable being paid out of them.

A lower price. The market rate, discovered.

Rules of thumb

• DSCR above 1.5 — comfortable. You have room for a bad quarter.
• 1.25–1.5 — bankable, with little margin for error.
• 1.0–1.25 — expect a larger down payment or a seller note.
• Below 1.0 — the business does not service the loan. Not financeable at that price.

One last thing

Compute the DSCR at documented earnings, not advertised ones — and then compute it again at documented earnings minus the cost of replacing the owner's labour.

If it survives both, you have a financeable business. If it only survives the first, you have a job that comes with a loan, and you should decide deliberately whether that is what you were shopping for.