Debt Service
The total annual principal and interest payments required to repay acquisition debt. If the business can't cover debt service, the transaction won't close — no matter the agreed-upon price.
Definition
Debt service refers to the periodic payments (usually monthly or annual) that a borrower has to make to repay a loan — principal repayment plus interest. In a business acquisition, it’s the amount the buyer will have to pay each year to repay the financing used to buy your business.
In French-language Quebec documentation, you’ll see service de dette used for the same concept.
For example, if a buyer borrows $1,500,000 over 7 years at 7%, annual debt service will be around $280,000. The business has to generate enough cash to cover that amount — on top of every other operating expense.
Why debt service matters in a business sale
Debt service is often the real ceiling on the sale price — not the theoretical multiple, not the strategic value, but the actual capacity of the business to repay the acquisition loan.
Canadian banks typically require a debt service coverage ratio (DSCR) of 1.2x to 1.5x. That means free cash flow has to exceed debt service by 20% to 50%.
Let’s take a concrete example. Your business generates free cash flow of $350,000 per year. With a required coverage ratio of 1.25x, maximum acceptable debt service is $280,000.
That caps the acquisition loan at around $1,500,000 over 7 years. If the buyer puts 20% down, the maximum financeable price is around $1,875,000 — even if your theoretical valuation is $2,500,000.
For you as a seller, understanding this mechanic matters. An asking price that exceeds financing capacity eliminates the majority of potential buyers.
Your broker will calculate the “financeable” price of your business from the start to set realistic expectations and target the right buyers.
What every seller should know
- Debt service is calculated by lenders from your normalized historical cash flows — not from optimistic projections.
- Interest rates have a direct impact on the financeable price. A 2% rate increase can reduce the accessible price by 10 to 15%.
- A vendor take-back (where the seller finances part of the price) is often needed to bridge the gap between the asking price and the buyer’s bank borrowing capacity.
- Maximizing free cash flow in the 2-3 years before the sale has direct leverage on the financeable price — every additional dollar of FCF translates into several dollars of borrowing capacity.