The Debt Service Coverage Ratio (DSCR) is a pivotal factor in SBA loan approval, assessing your business’s ability to cover debt obligations with available cash flow.

Calculation:
Annual EBITDA ÷ Annual Debt Service = DSCR

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) represents net operating income after expenses, excluding taxes and interest.
Annual Debt Service includes principal and interest payments on the proposed loan and existing debts.
Example: A business with $150,000 in EBITDA and a loan requiring $80,000 in annual payments yields a DSCR of $150,000 ÷ $80,000 = 1.88.

Significance: The SBA requires a minimum DSCR of 1.15, meaning your cash flow must cover debt payments at least 1.15 times. Lenders may prefer higher thresholds, such as 1.25 or 1.50, particularly for startups or acquisitions.

Startups vs. Acquisitions:

Startups: Rely on financial projections, necessitating a robust business plan.
Acquisitions: Use the combined EBITDA of the buyer and seller, providing more flexibility for established operations.

Maximum Loan Amount

The DSCR directly influences the maximum loan amount your business can borrow, providing clarity on your financing capacity.

Calculation:
EBITDA ÷ Required DSCR = Maximum Annual Debt Service

This figure is converted into a loan amount based on the loan term and interest rate.
Example: A business with $200,000 in EBITDA and a lender requiring a 1.25 DSCR can support $200,000 ÷ 1.25 = $160,000/year in debt service, equating to approximately $1.2 million over 10 years at 8% interest.

Startups vs. Existing Businesses:

Startups: Depend on projections, with DSCRs of 1.15–1.50 shaping loan size.
Acquisitions/Existing Businesses: Higher EBITDA supports larger loans, often with DSCRs of 1.50–1.75.

Loan-to-Value (LTV)

The Loan-to-Value (LTV) ratio compares the loan amount to the appraised value of assets securing it, a key consideration for acquisitions or real estate-focused loans.

Calculation:
Loan Amount ÷ Appraised Value of Assets = LTV

For acquisitions, the LTV is based on the combined value of the buyer’s and seller’s businesses.
Example: A $900,000 loan to purchase a $1 million business results in an LTV of $900,000 ÷ $1,000,000 = 90%.

SBA vs. Conventional:

SBA Loans: Many lenders set an internal LTV cap at 90%, often allowing up to 100% financing for acquisitions.
Conventional Loans: More restrictive, with LTV limits of 75–85%, frequently requiring down payments or seller financing.

Acquisition Considerations: If the buyer’s business is valued at less than 11% of the seller’s, SBA loans are often necessary to meet LTV requirements, as conventional loans may exceed their 33% threshold.

Debt and Debt-to-Income Ratio (DTI)

The Debt-to-Income Ratio (DTI) evaluates your personal financial capacity to manage both personal and business debts.

Calculation:
Personal Annual Debt Service ÷ Total Personal Income = DTI

Debt Service includes personal loans, mortgages, and credit card payments.
Example: With $30,000 in annual personal debt payments and $100,000 in income, DTI = $30,000 ÷ $100,000 = 30%.

SBA Standard: Lenders typically seek a DTI below 30–40%, though some apply DSCR methods to personal cash flow.

Net Worth

While no specific net worth-to-loan ratio exists, your net worth significantly influences lender confidence.

Components: Includes retirement accounts, home equity, investments, and other assets.

Impact:

High Net Worth: Enhances credibility, reducing perceived risk for startups and potentially waiving down payment requirements.
Low Net Worth: May lead to down payments or increased scrutiny, even if not formally mandated.

Personal Financial Statement

Transitioning from industry stability to the individual level, it's pivotal to understand that the Personal Financial Statement (PFS) is often the first checkpoint for lenders in evaluating a loan application. A robust PFS amplifies the prospects of securing a loan since it provides a comprehensive snapshot of an applicant's net worth, liabilities, and assets.

For conventional loans, the PFS is part and parcel of the loan application. However, when it comes to Small Business Administration (SBA) loans, the SBA 413 Form is the norm. Lenders instinctively skim to the bottom of the PFS to ascertain the net worth figure—a paramount indicator of financial health. They then dissect the list to assess debt and asset details, examining the proportions meticulously.

While a substantial personal net worth can color the lender's perception positively, it's crucial to recognize that net worth alone doesn't guarantee loan approval. There are cases where advisors with hefty net worths may struggle to secure a substantial acquisition loan, while those with more modest net worth figures might succeed. It emphasizes that net worth is a nuanced consideration with no concrete personal net worth-to-loan amount ratio.

Conventional lenders typically look for a net worth that's about 25% to 50% of the loan value, not counting the advisory business's value, whereas SBA lenders apply more flexibility due to the SBA's guarantee safeguard. What's clear, however, is that lenders view personal financial assets—including retirement accounts and personal investments—as positive indicators of an applicant's financial stability, though these assets are generally non-collateral.

Lenders also weigh an advisor's professional experience in conjunction with their net worth. An advisor with extensive experience but a modest net worth might be assessed differently compared to someone newer to the industry with similar financial standing.

Leveraging Cash Flow for Growth and Stability

How DSC Impacts Approval

For acquisitions, potential cash flow becomes a critical focal point for lenders. While criteria may differ, cash flow must meet specific thresholds to qualify. The favorable terms of SBA loans, including a generally lower Debt Service Coverage (DSC) requirement and a more attractive Loan-to-Value (LTV) ratio, significantly enhance borrowing capacity for advisors. These loans can reach up to $5 to $7 million, particularly advantageous when factoring in the lower DSC benchmarks that SBA lenders often employ. For instance, while the SBA generally sets a minimum DSC at 1.15, individual lenders may opt for higher internal benchmarks of 1.25 or 1.50. Traditional lenders, on the other hand, may look for a DSC of 1.50 or 1.75, though some may show leniency regarding previous years' financial performance.

The implications of these varying requirements are profound; under the more lenient SBA guidelines, advisors can access as much as 30% more funding compared to a conventional lender seeking a 1.50 DSC benchmark, and a staggering 52% more when contrasted with lenders enforcing a stringent 1.75 DSC minimum. Additionally, even among conventional lenders, a policy shift from a 1.50 to a 1.75 DSC could facilitate nearly 17% more in available loan dollars. Such financial metrics significantly influence the lending landscape, illustrating the critical role of cash flow in securing necessary capital for growth and stability in the advisory profession.

What’s Impacting Your Acquisition’s Cash Flow?

Rising costs and market shifts are eroding the ROI on advisor acquisitions. Here’s how soaring multiples, broker fees, interest rates, and amortization schedules challenge cash flow—and how AdvisorLoans helps you navigate them.

The Perfect Storm Eroding ROI

A combination of high revenue multiples, competitive buyer-to-seller ratios, and elevated interest rates is squeezing advisor acquisitions. A few years ago, practices sold at 2–2.5x revenue with a 3.25% prime rate. Today, the prime rate is 7.5% (down from 8.5%), and median multiples exceed 3x, per industry valuation firms.

Impact of Higher Multiples

Moving from a 2.5x to 3.5x multiple requires 20% more cash flow to qualify for the same acquisition, equivalent to a 5% interest rate hike. At 3.5x vs. 2x, you need 30% more cash flow. Financial practices are now among the priciest small businesses, pricing out 70% of advisors with books or lifestyle practices who can’t absorb low-ROI deals. Aggregators may overpay for future multiple gains, but typical advisors prioritize today’s cash flow for survival.

Broker Fee Premium

Paying a 6%–10% broker fee (or T12 percentage) significantly impacts cash flow. M&A brokers often secure sellers a 17%–20% premium over valuation, meaning buyers may pay 23%–30% above valuation price, excluding financing costs. A rule of thumb: a 6% broker fee plus a 15% premium on a 3x-valued practice equals a 20% extra premium on seller revenue, assuming a cash deal.

Interest Rates

Higher rates reduce borrowing capacity. A few years ago, SBA loans for advisors topped out at 6.5%; last year peaked at 11.5%. Qualifying for a $1M loan at 6.5% required ~$204K in profit; at 11.5%, you need ~$254K—25% more cash flow for the same loan amount. Today the prime rate is at 7.5% and SBA rates typically ranging from 9% to 10.5%.

Needed Amortization: Most advisor acquisition loans amortize over 10 years. SBA and conventional loans typically offer a 10-year term with matching amortization. Some lenders provide a 7-year term with 10-year amortization, or a 10-year term with 15-year amortization. At 3x valuations, 10-year amortization is often necessary for 100% bank-financed deals to cash flow effectively.

10 year term with 15 year amortization

AdvisorLoans exclusively offers this extended amortization acquisition loan option (at least for now anyway).

The loan is a 10 year term but payments are made based on a 15 year amortization. At the end of the 10 years there is a balloon payment. The balloon payment is made in one lump sum or if everything qualifies, be refinanced into a new note.

A 10 year term with a 15 year amortization can be utilized as a conventional loan option to either qualify for a 100% bank financed conventional loan or to lower monthly low payments to increase short term cash flow.

Three Schools of Thought for Selecting Term & Amortization

Advisors will typically view loan terms from three different perspectives. They want to pay the least amount of interest, or pay the least amount of monthly loan payment, or a combination of the two.

1. Least amount of interest paid

The school of thought for cost focused advisors. If you want the acquisition loan to cost you the least amount of total dollars then this is achieved by paying the least amount of interest dollars. The biggest impact on interest cost is not the rate but the amortization. Banks aren’t going to lower the interest rate by half but you can choose to cut your term in half. For a $1M loan at 6.5% rate on a 10 year term you would pay $362,575 in interest. But for a 7 year term the total interest would be $247,352 and for a 5 year term $173,968.

2. Least amount of monthly payment

The school of thought for cash flow focused advisors. If you want the acquisition loan to have the least amount of impact to your cash flow then this is achieved by having longer terms and/or amortization. For a $1M loan at 6.5% rate on a 5 year term the monthly payment is $19,566, for a 7 year term $14,849, for a 10 year term $11,354, and for a 10 year term with a 15 year amortization $8,711.

3. A cash flow and cost combination mindset

The school of thought held by most advisors who want the lowest monthly payment (especially in the first years after the acquisition) possible but also want to spend the least amount of total interest. This is achieved from getting a loan with a 10 to 15 year amortization schedule and then after the first year or two, or three, start knocking down the balance as quickly as you can through extra payments.

Most advisors approach acquisition loans with the combination mindset. The average lifespan of a ten year term loan for advisors is just under 6 years. SBA acquisition loans do not have pre-payment penalties. Many of the conventional lenders will allow up to 10% of the loan balance to be paid each year with no penalty. Some only have a prepayment penalty for the first 3 or 5 years. Even if you paid a 2% loan balance prepayment penalty on a chunk payment the interest savings far outweighs the penalty cost.

KEY RATIO CALCULATIONS

Debt Service Coverage Ratio (DSCR)