What on earth is a coverage ratio in financing with an SBA Loan?

When dealing with financing of various sorts you will come across the term "coverage ratio". It my be in the context of "Interest coverage ratio"  or "debt coverage ratio" or some other similar nomenclature.

Here's the basic concept of a coverage ratio. The coverage ratio is designed to determine what margin for error there is in a borrower's ability to pay back the debt.

Let's use an example assuming you are buying a business, here are some basics:

• Business Purchase Price $500,000
• Seller's Discretionary Earnings (SDE) $175,000 (Seller's discretionary earnings is the business earnings before Interest, Depreciation, Taxes, Amortization and Owner's Compensation).
• Down payment Buyer has available $100,000
• SBA Loan $400,000  financed for 10 years @ 7% =  $4,644 per month payment which = $55,750 per year.
• Salary the Buyer needs from business to pay living expenses  $100,000.

Coverage Ration Calculation  

SDE                                       $175,000

Salary needed                         $100,000

Available for Debt Service      $75,000

Amount of Debt service          $55,750

Coverage ratio is                     1.35   Amount available for debt service divided by actual debt service.

Generally speaking when seeking an SBA Loan the coverage ratio required will be between 1.25 and 1.4.

What Price is the Right Price to buy a Small Business

If you decide you want to buy a business you need to prepare yourself for the rather inconsistent pricing methodologies used for setting the asking prices for small businesses.

You shouldn't confuse the asking price for a business with the value of the business or what finance professionals call a Business Valuation or Business Appraisal. There are many ways to compute the value of a small business. The results can be wildly different and all correct. The issue isn't "what is a business worth?" as much as "what is the business value to you?". We'll breakdown the elements and suggest ways for you to go about the process of determining a fair value for a business.


For background it also might be helpful to read  "What do you Buy when you Buy a Business?" . Also, you might want to review this Case Study How to Buy a Business -  Case Study.

In this post we will discuss the elements that create small business value. As Business Brokers we have these discussions with buyers but more importantly we have the same discussions with business sellers.

Confidentiality when Buying a Business

A lot of things can go wrong when buying a business. Here's some background on the Importance of Confidentiality. If you want to buy a business....understanding this issue can be the difference between buying a business and losing a good opportunity. Below is a short slide presentation:







Library of 20 Articles about Buying a Business

Note: Please note that this information is copyright protected and can not be reproduced without the written consent of Sunbelt Business Brokers Houston Texas or Dan Elliott. 

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