Debt Service Ratio (DSR) also called Debt Coverage Ratio, is a ratio calculated by lenders to determine how comfortably a business can make its payments on a business loan. DRS calculations are made by SBA lenders and other lenders before deciding whether to approve a loan application, or how much it is willing to lend. DSR determines the level of risk a lender will be assuming if it makes a loan. All SBA lenders require a DSR of at least 1.25 times for borrowers with good credit, but many require a ratio of 1.5 times.

In order to calculate a DSR, it is first necessary to determine the loan applicant’s cash flow. Not all lenders calculate cash flow the same, but depreciation expense and amortization is never included as expenses when calculating cash flow.

Some lenders include the owner’s compensation as an expense, others exclude it as an expense. If is critically important to verify each lender’s precise formula. All lenders will carefully scrutinize all ad backs and will delete them if at all questionable.

Subject to the forgoing comments, the formula for calculating DSR is: Monthly Cash Flow Divided by Monthly Loan Payment.

Ideally, the ratio should be 1.5 times or 150% or more.

An equity kicker is a financial incentive whereby a lender provides credit at a lower than market interest rate in exchange for an equity position in the borrower's company. The equity kicker may take the form of stock or warrants.

 

Subordinated Debt

Subordinated debt is high risk, unsecured junior debt that ranks below senior debt, but above equity in the event of a liquidation. The interest rate on subordinated debt is always higher than on secured debt because the lender's risk of default is always higher. Subordinated debt is most common in mergers and acquisitions, and in private equity transactions where senior lenders cannot or will not provide full funding. The debt may be evidenced by bonds or a standard loan agreement.

 

Seller Financing

Seller financing, also referred to as owner financing, can be secured or unsecured financing where the owner or seller becomes the lender. Seller financing has both advantages and disadvantages to the seller and buyer, but this type of financing almost always results in an earlier closing. Seller loans may be assumable subject to defined conditions or they may not be assumable. Loans provided by sellers may be short-term loans and may have high interest rates. Terms vary depending on market conditions and the motivation of the parties. Sellers are always cautioned to check the buyer's credit score before offering financing.

 

Mezzanine Debt

Mezzanine debt is a type of hybrid debt that is subordinate to other debt. It is frequently associated with acquisitions, mergers and buyouts. Mezzanine debt is often long term debt with flexible repayment terms. The loans often provide the lender with warrants or options.

 

Evergreen Loans

An evergreen loan is a revolving line of credit requiring the borrower to pay only monthly interest. The principal is expected to be made at the end of the loan term which is usually two to three years from the effective date. These loans are regularly extended by the lender at maturity making them long term loans.

Chattel Mortgage

A Chattel Mortgage is a loan secured by personal property, also known as chattel, as opposed to real property, generally land and buildings attached to the land. Chattel mortgages are commonly secured by machinery, vehicles, manufactured homes, aircraft, and boats. To secure personal property, the lender files a UCC-1 Financing Statement to establish a public record of their interests. Chattel mortgages are made by some commercial banks. The interest rates are typically higher than on real estate loans and the terms are usually less favorable to the borrower. See: Security Agreements.

 

Non-Recourse Loans

A non-recourse loan is a secured loan that limits the lender's recovery to the collateral that has been pledged as security. This is nearly always real estate or marketable securities such as stocks and bonds. In the event of a default, the borrower is protected from personal liability unless he or she has committed fraud or other misconduct as defined in the loan agreement. Given that lenders can only look to the collateral for repayment, their risk is higher. Consequently, the interest rates and credit requirements for non-recourse loans are always higher. The majority of commercial banks will not make non-recourse loans. Those that will usually limit these loans to existing preferred customers with excellent credit.