Advanced Finance

Sizing the Debt

Work out how much debt a business can actually carry — as the minimum of four independent constraints, not the maximum number a lender is willing to quote.

  • Advanced
  • 9 min total
  • 12 chapters

What decision this helps you make: The quantum and shape of the debt in a financing or buyout: how many turns, in what tranches, on what amortization, with how much headroom.

What this topic is

Debt sizing is the exercise of converting a credit into a borrowing capacity. It runs four tests independently — what multiple of earnings the market will lend, what the cash flow can service in a downside, what leaves defensible covenant headroom, and what can plausibly be refinanced at maturity — and takes the lowest answer. The rest of the structuring work is allocating that answer across tranches.

Why it matters

Almost every leveraged transaction that fails, fails here rather than at the operating level. The business performs somewhere near plan, the structure was sized to a base case that had no room in it, and a routine miss becomes a default. Getting the quantum right is worth more than any subsequent piece of financial engineering.

Who should learn it

Deal professionals sizing a capital structure, CFOs negotiating a facility, credit investors underwriting one, and owners deciding how much borrowing their business can survive rather than merely obtain.

What you will understand

  • The four constraints, and how to test which one binds
  • Fixed charge coverage in a downside case, worked end to end
  • How covenant cushion is constructed, and what a realistic one looks like
  • Why the interest deduction limitation now changes the answer for capital-intensive borrowers

Prerequisites

Common misconception

"The lender said five and a half turns, so the business supports five and a half turns." A lender is quoting the maximum it will fund against a market and a credit at a moment in time — that is one of four constraints, and it is the one that says nothing about your business. Cash flow in a downside, covenant headroom through the plan, and refinanceability at maturity are the other three, and any of them can bind first. The capacity is the minimum of the four, and a lender is under no obligation to tell you which one you failed.