A sponsor asks for 6x adjusted EBITDA. Reported EBITDA is Rs 80 crore and the adjusted figure of Rs 100 crore includes Rs 20 crore of add-backs. What leverage is that on reported EBITDA, and which add-backs would you accept?

The request is 7.5x reported EBITDA; on the add-backs I would accept it is 6.9x, and I would lend about Rs 438 crore. Accept the legal settlement, the savings already in place and half of the new contracts: Rs 7.5 crore, giving Rs 87.5 crore. Reject recurring severance and unproven synergies. At 5.0x my EBITDA the loan is Rs 437.5 crore, 5.5x reported, with interest cover of 1.7x.

A loan applicant who says his salary is Rs 1 lakh a month, plus the raise he expects and the bonus he got once, is asking the bank to lend against money he does not yet earn. Leverage is debt divided by EBITDA, so every rupee added back to EBITDA raises how much can be borrowed at a given multiple: at 6x, each Rs 1 crore of add-back is Rs 6 crore of debt. The Rs 600 crore request is 6.0x on Rs 100 crore and 7.5x on the Rs 80 crore in the accounts. Interest at 11% would be Rs 66 crore, covered only 1.21x by reported EBITDA.

Test each against one question: will this profit be there, in cash, next year, without anything else having to happen? Accept the legal settlement in full, because it is paid and closed; accept Rs 3 crore of the Rs 5 crore of restructuring savings, the part already in place; accept half of the new contracts, because they are signed but not yet running. Reject the severance, because a cost booked as one-off three years running is a cost of doing business. Reject the synergies, because they depend on a merger that has not been agreed and will cost money to deliver. That leaves Rs 7.5 crore of the Rs 20 crore and a lender EBITDA of Rs 87.5 crore.

Measured three ways, the same request looks very different. Rs 600 crore is 6.0x the sponsor's EBITDA, 6.86x yours and 7.5x reported; a guarding business with an 8% margin and wage costs that rise every year cannot carry that. At 5.0x your EBITDA, the loan is Rs 437.5 crore, 5.47x reported, with interest of Rs 48 crore covered 1.66x by reported EBITDA. Then protect the definition: cap run-rate add-backs in the covenant at a share of EBITDA, require that savings be realised within twelve months or drop out, and test the covenant on your definition, not the sponsor's.

Say the limit too. The verdicts here are judgements, and a sponsor will argue each one: that the severance really will stop, that the synergies are in its control. The lender's answer is not that the sponsor is wrong but that the loan is sized on profit already earned, and if the add-backs arrive, the leverage falls and the sponsor can refinance on better terms. That is a reasonable trade for both sides.