Case 093Private credit and direct lendingWarm up
A sponsor asks for debt of 5x EBITDA of Rs 60 crore at 11%, with capex of Rs 10 crore and tax of Rs 8 crore. Work interest cover and free cash flow after debt service, and decide whether to approve.
1The situation
A sponsor is buying Madhupur Specialty Foods, which makes spice blends and ready mixes, and asks your private credit fund for a unitranche loan of 5x EBITDA. EBITDA is Rs 60 crore and has grown about 6% a year. The loan would carry 11% cash interest and 1% a year of scheduled amortisation, with the rest due in six years. Maintenance capex is Rs 10 crore a year and cash tax about Rs 8 crore. Working capital is stable.
Your fund's guidelines ask for interest cover above 2.0x at close and free cash flow after interest, tax and capex of at least 5% of debt.
2Your task
Work the interest, cover and free cash flow at 5x, test the loan against the guidelines, and say what you would approve.
Quick check
At 5x, roughly how much cash is left each year after interest, tax and capex?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Decline at 5x; approve at 4x. Rs 300 crore at 11% costs Rs 33 crore of interest, so cover is 1.8x, below 2.0x, and free cash flow after interest, capex and tax is Rs 9 crore, 3% of debt, below 5%. Nothing meaningful repays the loan and a 15% fall in EBITDA leaves nothing at all. At 4x, Rs 240 crore, cover is 2.3x and free cash flow Rs 15.6 crore, 6.5% of debt, and the sponsor funds the gap with equity.
Step 1What does the loan cost the company each year?
Start from the debt, not the EBITDA multiple. A family that borrows five years of income at 11% pays more than half its income in interest, whatever the bank's brochure says about affordability. Five times Rs 60 crore is Rs 300 crore; at 11% that is Rs 33 crore of interest a year, 55% of EBITDA, so interest coverEBITDA divided by cash interest. It says how many times over the business earns its interest bill before capex and tax. is 1.8x. The guideline says 2.0x. The loan fails the first test before anything else is counted.
Step 2How much cash is left to repay the loan?
Take interest, capex and tax off EBITDA. Rs 60 less Rs 33 of interest, Rs 10 of capex and Rs 8 of tax is Rs 9 crore, 3% of a Rs 300 crore loan, against a 5% guideline; after the 1% amortisation of Rs 3 crore, Rs 6 crore is left. At that pace the company needs about 7 years of flat EBITDA to get from 5x to 4x, and the loan matures in six. Approval rests on free cash flow after debt service, because that is what actually repays a lender; EBITDA leverage is a shorthand for it that works only when interest rates are low.
| Rs crore | 5.0x | 4.5x | 4.0x |
|---|---|---|---|
| Debt | 300 | 270 | 240 |
| Interest at 11% | (33.0) | (29.7) | (26.4) |
| Interest cover | 1.82x | 2.02x | 2.27x |
| Capex and tax | (18) | (18) | (18) |
| Free cash flow | 9.0 | 12.3 | 15.6 |
| Free cash flow as % of debt | 3.0% | 4.6% | 6.5% |
Step 3What do you approve, and what do you say to the sponsor?
Offer Rs 240 crore, 4x, and let the sponsor put in Rs 60 crore more equity. At 4x the loan passes both tests with a little room: a 26% fall in EBITDA still leaves cash after interest, capex and tax, against 15% at 5x. If the sponsor insists on 5x, the structure that might work is 4x of cash-pay debt plus a PIK trancheDebt whose interest accrues to the balance instead of being paid in cash, so it does not consume the cash flow the senior lender relies on. for the last turn, priced for the risk, with a cash sweep on the senior piece. Say the limit of the analysis too: it holds EBITDA flat, and 6% growth helps, but a lender underwrites the downside and lets the sponsor keep the upside.
Where candidates lose it
The usual loss is approving on leverage: 5x on a growing food business sounds ordinary. The interviewer wants interest and cash computed, and at 11% the arithmetic says no before any judgement is needed.
The second is quoting free cash flow before interest, Rs 42 crore, as the repayment capacity. The lender is repaid from what is left after its own interest, which here is Rs 9 crore.
What the interviewer asks next
- EBITDA grows 6% a year as the sponsor projects. In which year does the 5x loan reach 4x on its own?
- The sponsor offers a 50% cash sweep instead of lower leverage. Does that fix the problem?
- Why do private credit funds price in cash interest cover when banks sometimes look only at leverage?
Company names and figures are illustrative.