Module IV· Debt RatiosIntermediate
Question
What is the difference between 'leverage at closing' and 'through-the-cycle leverage'?
Answer
What
Two views of leverage, discussed separately in the pitch and in the IC memo:
- Leverage at closing: Senior Debt / EBITDA on the closing day (LTM or adjusted). The pricing discussion with the lender.
- Through-the-cycle leverage: the average ratio over the hold period, on a normalized EBITDA base. The risk view in the investment committee.
Why both? Cyclical sectors (construction, automotive) show moderate leverage at closing that rises sharply in the mid-period — the critical phase for covenant design.
Deep diveShow more details
Example — middle-market carve-out, cyclical sector
| Year | EBITDA | Senior Debt | Leverage |
|---|---|---|---|
| 0 (closing) | $50m (peak) | $250m | 5.0x |
| 1 | $45m | $220m | 4.9x |
| 2 (trough) | $35m (cyclical low) | $195m | 5.6x |
| 3 | $42m | $175m | 4.2x |
| 4 | $50m | $150m | 3.0x |
| 5 (exit) | $55m | $130m | 2.4x |
| Through-the-cycle avg | $46m | $186m | ~4.0x |
Use in modeling
- "Leverage at closing" for the pricing discussion with the lender.
- "Peak leverage" (Year 2 here) for covenant design: the cushion must fit it.
- "Through-the-cycle" for the IC memo: the long-term risk view.
For cyclical targets the closing leverage looks moderate, but the mid-period can trigger a covenant breach.
Pitch tip
Question: "In which year is leverage highest?"
Answer: "Year 1–2, because EBITDA is not yet fully synergized AND senior debt is still almost unchanged. The cushion on the maintenance covenant is tightest in this phase — typically 20–25%"