What "debt capacity" actually means
Debt capacity is the maximum debt a business can carry before either (a) lenders refuse to underwrite more, or (b) covenants force the borrower into default. The two constraints are different: a leverage cap (e.g., "debt cannot exceed 5.5x EBITDA") is a structural ceiling negotiated at close; a coverage covenant (e.g., "EBITDA / interest must remain above 2.5x") is an ongoing performance test.
For acquisition financing — LBOs, SBA deals, search-fund buyouts — the binding constraint usually flips between the two depending on where rates are. In a 4% rate environment, leverage caps bind first. In an 8% rate environment, coverage covenants bind first. The calculator above shows both and reports which one is tighter.
The two constraints, side by side
Leverage-based: max debt = EBITDA × leverage_x
The simplest constraint. Lenders publish target leverage ranges for different deal types — typically 4-6x for sponsor-backed LBOs, 2-3x for SBA acquisitions, 5-7x for unitranche financings. Multiply by the target's EBITDA and you have a gross debt ceiling. Easy to model, easy to negotiate.
What it doesn't consider: whether the business can actually service the resulting debt at current interest rates. A 5x leverage cap at 4% interest is one thing; at 8% interest the same 5x produces a debt service load that may be unservicable. That's where the coverage constraint comes in.
Coverage-based: max debt = EBITDA / (rate × min_coverage)
The coverage constraint sizes debt so that EBITDA covers interest (and sometimes principal) by a specified multiple. Solve for the debt amount that exactly hits the coverage minimum:
max_debt = EBITDA / (rate × min_coverage)
At 8% interest and 2.0x minimum interest coverage, a $50M EBITDA business can support up to $312M of debt — but only if its EBITDA actually stays at $50M. The covenant binds inevery reporting period, not just at close.
DSCR vs interest coverage — pick the right one
Two related but distinct ratios:
- Interest coverage = EBITDA ÷ Interest expense. Tests whether the business generates enough cash to pay theinterest on its debt. Typical minimum: 1.5x to 3.0x.
- DSCR (Debt Service Coverage Ratio) = EBITDA ÷ (Interest + Principal amortization). Tests whether the business can cover total debt service, including mandatory amortization. Typical minimum: 1.15x to 1.25x for SBA loans, 1.0x-1.2x for term loans with amortization, higher for cash-flow notes.
DSCR is the harder test because it includes principal repayment. A business that comfortably covers interest can still fail DSCR if amortization is aggressive — common in SBA 7(a) loans, which fully amortize over 10 years on a stated schedule. The calculator outputs both so you can see which constraint binds.
What killed Toys R Us, in this framework
In 2005, KKR/Bain/Vornado bought Toys R Us for $6.6B EV at 5.7x leverage, which translated to ~$5.3B of debt at close. Annual interest expense ran ~$400M against $550M of EBITDA, leaving the business with interest coverage of just 1.4x. That was already tight — and it assumed EBITDA stayed at $550M.
When Amazon started taking toy share in the 2010s and EBITDA fell toward $400M, interest coverage dropped to ~1.0x. The covenants either tripped or were close enough that lenders refused to refinance. With $400M/year of interest, there was no cash flow left for the e-commerce CapEx the business desperately needed. The capital structure foreclosed the strategy.
The lesson for the calculator above: stress-test minimum coverage at downside EBITDA, not just current. If a 30% EBITDA decline trips your coverage covenant, the deal is more fragile than the leverage number alone suggests.
Lender behavior the calculator doesn't show
- Springing covenants. Many sponsor-backed loans have weaker maintenance covenants at close that "spring" to tighter ratios after specific triggers (an acquisition, a dividend recap, year-over-year EBITDA decline). The covenants you negotiated at signing aren't necessarily the covenants you operate under in year 3.
- EBITDA add-backs. Most credit agreements allow sponsor add-backs to EBITDA — synergies, run-rate savings, one-time items. The covenant tests against "Adjusted EBITDA" not GAAP EBITDA. Aggressive add-back schedules can mask deteriorating real performance for quarters before lenders catch up.
- Cash sweeps. Most term loans require excess cash flow above a threshold to sweep against debt. The sweep accelerates debt paydown and tightens the constraint — but only if there's excess cash to sweep. In a downturn the sweep kicks in zero, but the covenant doesn't loosen.
Using the calculator for an actual deal screen
Two ways to run it:
- Top-down: set your target leverage (e.g., 5x), assumed rate, and minimum coverage requirement. See whether the leverage you want is supportable at current rates and EBITDA.
- Coverage-first: set the minimum coverage you need (1.25x DSCR for SBA, 2.0x interest coverage for sponsor-style), solve for the max debt the business can hold, and back into the implied leverage.
The full All-in-One model below extends this with a true debt schedule (multiple tranches, mandatory and cash-sweep amortization, PIK accrual), real interest schedules, and quarterly covenant tests across a 5-year projection. The calculator gives you the 30-second screen.