Guide · 10 min read
The leverage ratios lenders use on acquisition debt: net debt to EBITDA, interest cover, debt service cover and fixed charge cover, how they are calculated, the bands UK banks and debt funds work to, and how covenants are set.
Written by Matt Lenzie · Published 3 September 2026
Advice from Matt Lenzie · 25-year career banker (Bank of Scotland, Lloyds Banking Group). £400m+ raised for clients.
Founder profile →The debt to EBITDA ratio measures how many years of earnings before interest, tax, depreciation and amortisation it would take to repay a company's borrowing. It is the single number that decides how much a UK acquisition lender will advance, and every other leverage ratio in a facility agreement exists to check what it does not.
Getting these ratios right before a price is agreed is the difference between a deal that gets through credit and one that gets rewritten at the last minute. This guide sets out the four ratios that appear in almost every UK acquisition facility, works each one through with real numbers, gives the indicative bands banks and debt funds are working to as at September 2026, and explains how the ratios become covenants with headroom and step-downs.
Net debt to EBITDA is a company's interest-bearing borrowing, less freely available cash, divided by its earnings before interest, tax, depreciation and amortisation for the last twelve months. It is expressed as a multiple, spoken as "turns" of leverage, and answers a blunt question: how many years of current earnings does this debt represent?
The formula is simple. The definitions are where deals are won and lost.
Worked example. A target has £11 million of borrowing after completion, £1 million of freely available cash and adjusted EBITDA of £4 million. Net debt is £10 million and leverage is 2.5x. Add a £600,000 hire purchase book that the buyer had treated as off balance sheet and net debt becomes £10.6 million, leverage 2.65x. That 0.15x difference sounds trivial and can be the difference between fitting a 2.75x covenant and breaching it in the first test period.
Because cash on the balance sheet can repay debt, so counting it twice overstates risk. A business with £12 million of loans and £4 million of sitting cash carries an £8 million economic obligation, and a lender that ignored the cash would decline deals it should approve.
The qualification is the word "freely". Cash held as a customer deposit, cash in a blocked account securing a bond or a lease, cash needed to fund the next payroll and seasonal working capital cash are not available to repay debt. Facility agreements therefore net only unrestricted cash, and a buyer building a sources and uses schedule should assume the lender will strip out anything the business genuinely needs to trade. Where a target's cash balance is really a working capital float, the honest leverage number is closer to the gross figure.
There is no universal threshold, but there are bands the market works to. As at September 2026 the indicative picture for UK acquisition and buyout debt looks like this: senior debt of 2.5x to 3.5x EBITDA from banks, and total debt of 3.5x to 5.0x EBITDA where unitranche or mezzanine is layered on top, with sponsor and management equity of 30% to 50% of enterprise value. Those are indicative bands only and every case is assessed on its own facts.
Within them, sector and earnings quality do the work:
The sector overlay is stronger than most buyers expect. Software and business services with contracted revenue support the top of each band. Recruitment, construction, hospitality, haulage and anything with a heavy capital expenditure cycle or a cyclical order book supports considerably less, whatever the trailing EBITDA says. A lender's real question is not what the multiple is but how confident it is that the earnings will still be there in year three.
Interest cover is EBITDA divided by net interest payable, and it tests whether earnings can carry the cost of the debt regardless of how quickly the principal is repaid. Continuing the worked example, £4 million of EBITDA against £10 million of senior debt drawn at 8.5% gives interest of £850,000 and interest cover of 4.7 times.
UK acquisition facilities typically covenant interest cover at a minimum of 2.5x to 3.0x, sometimes 4.0x on a conservative bank package. The ratio has become considerably more important since the interest rate cycle turned, because a facility priced over Bank Rate or SONIA sees its interest bill move without any change in trading. A business with cover of 3.0x when its debt cost 5% has cover of about 1.9x if the all-in cost reaches 8%, which is why lenders require hedging on a substantial portion of the senior debt as a condition of drawdown.
Interest cover is also the ratio that most flatters a bullet structure. A unitranche facility with no amortisation shows strong interest cover throughout its life and repays nothing at all until maturity, so the leverage covenant and the refinancing plan carry the risk that amortisation would otherwise have addressed.
Debt service cover, usually written DSCR, is the cash flow available for debt service divided by the interest and capital actually falling due in the period. Unlike interest cover it is a cash measure and it counts repayments, which makes it the binding constraint on almost every amortising acquisition loan.
The calculation, in the order a credit paper builds it:
Worked through on the same target: EBITDA £4.0 million, corporation tax of about £600,000 at the 25% main rate, maintenance capital expenditure £600,000 and working capital absorption £200,000 leaves £2.6 million of cash available. Against £10 million of senior debt at 8.5% amortising over eight years, debt service is £850,000 of interest plus £1.25 million of capital, so £2.1 million, and cover is 1.24 times. Against £12 million of debt on a six year profile, debt service rises to about £3.0 million and cover falls to 0.87 times, which no credit committee approves.
That is the mechanism by which cover, not leverage, sets the loan. The £12 million structure represents 2.75x net leverage, comfortably inside the bands above, and it still fails. Most UK lenders want DSCR of at least 1.20x to 1.30x on the base case, with the structure still above 1.00x in a stressed case. The leverage ratio calculator runs all three ratios from your own figures, and the business acquisition loan calculator shows how the amortisation profile moves the answer.
Fixed charge cover widens debt service cover to include the other unavoidable payments a business makes. The numerator is EBITDA before rent and operating lease costs, and the denominator adds rent, operating lease payments and hire purchase instalments to interest and amortisation.
It matters wherever fixed obligations outside the loan are large: retail and leisure businesses with rented estates, logistics companies with leased fleets, and manufacturers with substantial hire purchase books. A leveraged retailer can show acceptable leverage and acceptable debt service cover and still be fragile, because rent consumes the headroom. Asset based lenders and clearing banks both use the ratio, typically covenanting it at 1.10x to 1.25x, and its main value is that it makes a business with an off balance sheet cost base comparable with one that owns its premises.
| Ratio | Formula | Typical UK covenant level (indicative, September 2026) | What it actually tests |
|---|---|---|---|
| Net debt to EBITDA (total leverage) | (Total borrowing less freely available cash) divided by adjusted EBITDA | Maximum 3.0x to 3.5x on bank paper, up to 5.0x with unitranche or mezzanine | How many years of earnings the debt represents, and therefore the size of the loan |
| Senior net debt to EBITDA | (Senior borrowing less cash) divided by adjusted EBITDA | Maximum 2.5x to 3.5x | The first-ranking lender's own exposure, tested separately where there is junior debt |
| Interest cover | Adjusted EBITDA divided by net interest payable | Minimum 2.5x to 4.0x | Whether earnings carry the cost of the debt, and the sensitivity to rate moves |
| Debt service cover (DSCR) | (EBITDA less tax, less maintenance capital expenditure, less working capital absorption) divided by interest plus scheduled amortisation | Minimum 1.20x to 1.30x | Whether cash covers interest and repayments together. Usually the binding test |
| Fixed charge cover | EBITDA before rent and operating leases divided by interest, amortisation, rent and lease payments | Minimum 1.10x to 1.25x | Whether the business covers every fixed obligation, not only the loan |
| Cash conversion | Operating cash flow divided by EBITDA | Monitored rather than covenanted, 80% and above preferred | Whether reported earnings turn into cash a lender can be repaid from |
Levels are indicative bands for UK acquisition and buyout debt as at September 2026, not offers, and the definitions that apply to any given deal are the ones written into its facility agreement.
A covenant is a ratio plus a level plus a test date. UK acquisition facilities usually test leverage and cover quarterly on a rolling twelve month basis, with a compliance certificate signed by a director and delivered with the management accounts. Breach a covenant and the facility becomes repayable on demand, whether or not the lender chooses to act.
Headroom is the gap between the forecast ratio and the covenant level, and negotiating it properly is the most valuable thing that happens between credit approval and signing. A leverage covenant set at 2.75x against a forecast of 2.5x gives 9% of headroom on leverage, which is another way of saying that a 9% earnings shortfall triggers a breach. We generally look for a covenant package that survives a 15% to 20% reduction in EBITDA, because that is the size of miss businesses actually make.
Two features change the ratios over time. Step-downs tighten the covenant each year as the loan amortises, so a leverage covenant might run 3.50x, 3.00x, 2.50x, 2.00x across four years. They are logical and they are also the most common cause of a year two or year three breach, because the schedule assumes deleveraging that trading has to deliver. A margin ratchet works in the borrower's favour: the interest margin falls as leverage falls, typically in 25 basis point steps at half-turn intervals, rewarding early repayment with a lower cost of debt.
Well negotiated facilities include an equity cure right, allowing shareholders to inject cash to remedy a breach a limited number of times over the term, and a definition of EBITDA that permits genuine one-off costs to be added back. Both are far cheaper to obtain at documentation stage than to request in a waiver negotiation.
Serious ones, and every experienced lender knows them.
EBITDA ignores capital expenditure, so it treats a haulage company that must replace its fleet every five years the same as a consultancy that needs laptops. It ignores tax and working capital, both of which are real cash. It is not a defined measure under FRS 102 or any other accounting framework, so it can be constructed differently by two advisers on the same accounts, and the add-back schedule in a vendor's information memorandum is usually the most optimistic document in the pack. And on a trailing twelve month basis it captures a moment that may not be representative, which is why lenders look at three years and at monthly trends rather than a single figure.
The response is not to abandon the ratio but to triangulate. That is exactly why a facility agreement contains four or five covenants instead of one: leverage sizes the loan, interest cover tests the rate risk, debt service cover tests the cash, fixed charge cover tests the wider obligations and cash conversion tests whether the EBITDA was ever real. A structure that passes all of them in a downside case is a structure that survives.
We run them before anything else. Given a target's last two filed accounts and current management figures we build the adjusted EBITDA, the pro forma net debt, and the debt service cover at several debt quantums, then work backwards to the loan the cash flow supports rather than forwards from the price the vendor wants. That number is often lower than a buyer hopes, and it is considerably cheaper to discover before an offer than during due diligence.
From there the structure is a question of which instruments fill the gap: amortising senior debt for the cheap core, cash flow lending where there are few hard assets, asset based lending against debtors and plant, a vendor loan for the top slice, and mezzanine finance only where the price genuinely requires it. We then take the case across our panel of 40+ banks, debt funds and asset based lenders and negotiate the covenant levels, the step-downs and the cure rights alongside the pricing, because a cheap facility with no headroom is not cheap.
Bring 25 years in banking with significant transactional experience including leveraged buyouts and acquisitions, and £400m+ raised, to bear on your own numbers by reading our guides to how to finance a business acquisition and leveraged buyout structure, or speak to us about the specific deal. Management teams buying their own employer will also find our sister site MBOFinance.co.uk useful.
For a UK trading company borrowing from a bank, net debt to EBITDA below 2.0x is comfortable, 2.0x to 3.0x is normal for a funded acquisition, 3.0x to 4.0x is leveraged and needs a strong cash conversion story, and above 4.0x is debt fund territory rather than clearing bank territory. Those are indicative bands as at September 2026 and they move with sector: a software business with contracted recurring revenue is financed at multiples a construction contractor would never be offered. The more useful question is not what number is good but whether debt service cover stays above 1.25x in a downside case, because that is the test a business actually fails.
Divide net debt by EBITDA for the last twelve months. Net debt is all interest-bearing borrowing, which means bank loans, overdrafts, invoice discounting drawn, asset finance and hire purchase, and finance lease obligations, less freely available cash. EBITDA is operating profit with depreciation and amortisation added back. A company with £11 million of borrowing, £1 million of cash and £4 million of EBITDA has net debt of £10 million and leverage of 2.5x. In a covenant the definitions are whatever the facility agreement says they are, which is why the definitions clause deserves as much attention as the ratio level.
Debt to equity is a different measure from debt to EBITDA and answers a different question: how much of the balance sheet is funded by borrowing rather than shareholders. At 1.7 there is £1.70 of debt for every £1 of equity, which is high for a manufacturer and unremarkable for a property-backed or leasing business. Acquisition lenders in the UK rarely covenant debt to equity, because after a leveraged buyout the accounting equity is often small or negative once goodwill and shareholder loan notes are accounted for under FRS 102. They test earnings-based ratios instead, because earnings are what repays the loan.
That is a sovereign measure and it has nothing to do with corporate credit assessment, although the two get confused because both are called leverage. Government debt to gross domestic product compares a national stock of debt with a year of national output, and there is no threshold at which it becomes automatically unsafe. Corporate leverage is assessed on cash flow available for debt service, security, covenant headroom and the durability of earnings. If you have arrived here from a macroeconomics search, the ratios on this page are the ones a UK credit committee will apply to your company, not to the country.
Interest cover tests whether earnings can pay the interest bill: EBITDA divided by net interest payable. Debt service cover tests whether cash can pay interest plus capital repayments, and it is calculated on cash flow after tax and maintenance capital expenditure rather than on EBITDA. Interest cover is therefore the softer test, and on an amortising acquisition loan it is almost always debt service cover that binds first. A structure showing interest cover of 3.5x and debt service cover of 1.05x is not comfortable; it is a business that can afford its interest and not its repayments.
A step-down is a scheduled tightening of a covenant level over the life of the facility. A leverage covenant might be set at 3.75x for the first year, then 3.25x, 2.75x and 2.25x as the debt amortises, on the logic that leverage should fall as the loan is repaid. Step-downs are a common source of a breach in year two or three, because the covenant tightens faster than trading improves. They are negotiable at credit approval stage and painful to renegotiate afterwards, which is why we model the covenant schedule against the downside case before terms are accepted rather than after.
In most UK facility agreements, yes. Bank borrowing, overdrafts, drawn invoice discounting, asset finance, hire purchase and finance lease obligations are normally all included in the definition of financial indebtedness, and cash is netted off only to the extent it is freely available rather than restricted or held in a blocked account. Buyers are frequently surprised by how much a target's leverage rises once the lease book is added. Whether operating leases capitalised under a particular accounting treatment count is a drafting point worth settling early, because it can move the ratio by half a turn.
This guide is general information about unregulated business lending, not tax, legal or accounting advice. All ratios, bands and pricing are indicative as at September 2026 and every case is underwritten on its own merits. Lenzie Consulting Ltd is not authorised or regulated by the FCA; we arrange unregulated business finance for limited companies and LLPs only.
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