Module IV· Debt RatiosIntermediate
Question
What is a 'Debt/EBITDA step-down' and how does the sponsor negotiate it?
Answer
What
A step-down is a maintenance covenant limit that reduces over time — in parallel with the expected de-leveraging. It lets the lender ensure the sponsor actually delivers its modeling assumptions.
Example
| Period | Senior Debt / EBITDA limit |
|---|---|
| Year 1 | 5.5x |
| Year 2 | 5.25x |
| Year 3 | 5.0x |
| Year 4 | 4.75x |
| Year 5–6 | 4.5x |
Deep diveShow more details
Negotiating positions
| Position | Sponsor wants | Lender wants |
|---|---|---|
| Initial limit | high (5.75x+) | low (5.0–5.5x) |
| Step-down pace | slow (0.1x p.a.) | fast (0.25x p.a.) |
| End level | high (4.5x) | low (3.5x) |
| Cushion to forecast | 35–40% | 15–20% |
Example negotiation
The modeling forecast shows senior leverage at 4.5x at closing, falling to 3.5x over 5 years. The sponsor negotiates an initial 5.75x, stepping down to 4.75x in Year 3 and 4.25x in Year 5. Cushion: 5.75 − 4.5 = 1.25x = 28% — within the market range.
Common pitfalls
- Step-down too aggressive: a small EBITDA setback triggers a covenant breach.
- Step-down "cliff" at year-end: a better negotiation is gradual stepping across quarters.
Pitch tip
Question: "Which step-down is negotiable?"
Answer: "The sponsor wants 0.1–0.15x p.a., the lender wants 0.25x p.a. Compromise: 0.15–0.2x with a 25–35% cushion at closing. The step-down should stay behind the modeling forecast, otherwise the safety margin is gone"