How to Test Deal Bankability Before You Call the Bank

DSCR is necessary but not sufficient

Ask most buyers if their deal is bankable and they will quote the DSCR. It is 1.8x, the bank wants 1.25x, we are fine. They might be. But DSCR is one number in a system of constraints. A deal clears the ratio and still fails because the working capital requirement absorbs all the free cash, because the equipment replacement cycle hits in year two, or because the covenant structure leaves no headroom for a single bad quarter. The ratio is the ticket to the conversation. The structure is what gets approved.

Step one, the cash flow waterfall

Start with SDE, not EBITDA, because in an owner-operated acquisition SDE is what you actually have to work with. Then subtract, in order: a replacement salary, annual capital spending, and debt service. What falls out the bottom is the buyer's free cash flow, and if that number is negative, the deal does not work at the asking price. Full stop.

Each subtraction deserves honesty. The replacement salary is what it actually costs to hire someone to do what the owner does, not the template figure. For a construction company owner who runs estimates, manages crews, and holds the banking relationship, that might be $180,000. For the passive owner of a car wash, it might be $50,000. Capital spending is what it actually takes to maintain operations, not the CIM's low-maintenance claim: if the business shows $200,000 in annual depreciation and claims $50,000 in capex, someone is deferring maintenance and the bill is in your future. Debt service is the payment on the acquisition loan, and for SBA deals that typically means eighty to ninety percent of the price at today's rates, amortized over ten years. Know the payment before you fall for the deal.

Step two, the capital structure

How the deal is funded changes whether it works. The equity injection, usually ten to twenty percent down, has to come from somewhere real: savings, retirement rollover, partner capital. The SBA loan carries the rate, term, and amortization that set your payment. A seller note, often five to fifteen percent on standby, flatters your early coverage precisely because you are not paying it yet, and then year three arrives, the standby ends, and your coverage drops just as the honeymoon does. And many banks require a working capital reserve of three to six months of operating expenses, which comes out of your pocket, not the loan. Each piece moves the coverage math differently across time, which is why a structure that works in year one can bind in year three.

Step three, the covenants

The bank does not check coverage once at closing. The loan arrives with covenants, ongoing requirements measured every quarter or every year: a minimum DSCR, typically 1.25x, below which you are in technical default; fixed charge coverage, which folds in rent, insurance, and every other obligation; a leverage ratio the bank expects to improve over time; sometimes a minimum working capital ratio. Here is the arithmetic that matters: if your deal structures at 1.35x against a 1.25x covenant, you have one bad quarter of headroom. That is not bankable, that is a ticking clock with a loan attached.

Step four, the sensitivity matrix

This is the step most buyers skip and the reason most deals get repriced later. Take your coverage number and stress it: revenue down five percent, a normal bad quarter. Down ten, a recession or a lost major customer. Down fifteen, the key-person risk coming true. Capital spending fifty percent over budget, the machine your inspection flagged. Working capital needs up twenty percent, the seasonality the CIM smoothed over. Then compare shapes, not headlines: a deal at 2.0x coverage that falls to 0.9x at minus ten percent revenue is more fragile than a deal at 1.6x that only falls to 1.3x. The second deal has structural resilience. The first has fragility wearing a good headline.

What banks actually look at

Most lenders want a minimum DSCR around 1.25x measured annually, but the number moves with the risk: stable industries clear at 1.25x while volatile ones need 1.5x, and the ratio is only the start. The loan officer also weighs management experience, because a first-time buyer and a seasoned operator are different risks on the same deal. Collateral coverage, what actually secures the loan. The transition plan, how long the seller stays and whether there is a management team or whether you are the team. And the quality of the cash flow itself, because recurring revenue gets more credit than project work. Two identical ratios can get two different answers.

Test before you ask

Walking into a bank without this analysis spends something you cannot easily replace. The banker remembers every deal you bring that does not structure, and after two or three, the calls stop being returned. So run the waterfall, test the covenants, stress the scenarios, and know what the bank will say before you ask. If the deal fails at full asking price, the analysis tells you exactly how far the price must fall before it works, and that number becomes your negotiation position. Bankability is not a yes or a no. It is a price. The question is at what purchase price this deal structures.

Where this fits

Bankability is one of the two masters that set every real price; the other is what the market has actually paid, and how they meet is the whole story of what a business is worth. If the deal passes the stress test, the next phase is diligence, where the CIM's claims get tested against the actual financial records and the add-backs earn their keep or die.