What it means
Buyers use debt because it magnifies the return on the cash they put in. If a business bought for $40,000,000 later doubles in value, an investor who funded only $16,000,000 of that price with equity earns a far higher percentage return than one who paid the whole amount in cash.
The same effect works in reverse, which is why lenders cap it. Interest falls due whether trading is strong or weak, so a highly leveraged buyer has much less room for a poor year than an unleveraged one.
Sizing is expressed in multiples of EBITDA, meaning earnings before interest, tax, depreciation and amortisation, a rough proxy for operating cash flow. Mid market lenders commonly stretch to somewhere between two and four times EBITDA for total senior debt, with more available where revenue is contracted and predictable.
Acquisition debt usually arrives in layers. Senior term loans sit first in the repayment queue at the lowest rate, mezzanine or subordinated debt sits behind them at a higher rate, and vendor loan notes, where the seller waits for part of the price, often close the final gap.
The same words appear in personal tax with a narrower meaning. There, acquisition debt is borrowing used to buy, build or substantially improve a main home, as distinct from home equity borrowing taken out for other purposes, and the distinction decides how much interest is deductible.
In practice
Real-world examples.
Example
A private equity fund buys a chain of veterinary clinics for $55,000,000, funding $30,000,000 with senior acquisition debt and $25,000,000 from its investors. Repayments are set against the clinics' contracted subscription revenue rather than the fund's other holdings.
Example
A family owned printing firm buys a competitor for $6,000,000 using $3,500,000 of bank debt, $1,500,000 of cash and a $1,000,000 vendor loan note repayable over three years. The vendor note keeps the seller financially interested in a smooth handover.
Example
A homeowner borrows $420,000 to buy a house and later takes a further $80,000 against the same property to fund a business. Only the original $420,000 counts as acquisition debt for mortgage interest relief, and the extra borrowing is treated differently.
Formula
Calculation
Total consideration = acquisition debt + equity
Leverage multiple = acquisition debt / EBITDA
Interest cover = EBITDA / annual interest
A buyer acquires a manufacturing business for $40,000,000. The target's EBITDA is $8,000,000, so the entry multiple is $40,000,000 / $8,000,000 = 5.0 times earnings.
The bank provides $24,000,000, which is $24,000,000 / $8,000,000 = 3.0 times EBITDA, and the buyer funds the remaining $40,000,000 - $24,000,000 = $16,000,000 in equity. At an interest rate of 9%, annual interest is $24,000,000 x 9% = $2,160,000, giving interest cover of $8,000,000 / $2,160,000 = 3.70 times.
Stress testing shows how quickly that comfort disappears. A 25% fall in EBITDA to $6,000,000 cuts cover to $6,000,000 / $2,160,000 = 2.78 times, still inside a typical 2.5 times covenant, but a fall to $5,000,000 gives $5,000,000 / $2,160,000 = 2.31 times and breaches it.Case study
Seen in the real world.
This is an illustrative, fictional case. Brenwood Partners, an invented buyout firm, acquired Talgarth Coatings for $18,000,000, which was 6.0 times its $3,000,000 EBITDA. The structure used $10,500,000 of senior acquisition debt at 8.5%, equal to 3.5 times EBITDA, with $7,500,000 of equity behind it.
At completion the numbers looked comfortable. Annual interest of $10,500,000 x 8.5% = $892,500 gave interest cover of $3,000,000 / $892,500 = 3.36 times, well clear of the 2.5 times covenant in the facility agreement.
Two years into the fictional hold period, the loss of a single large customer cut EBITDA by 30% to $2,100,000. Cover fell to $2,100,000 / $892,500 = 2.35 times, which breached the covenant even though the business was still profitable and still paying its interest. The lender agreed a waiver in exchange for a fee, a higher margin and an $800,000 equity injection, which is the standard reminder that acquisition debt punishes volatility rather than losses alone.
Watch out
Common mistakes.
- Judging affordability from the interest bill alone and ignoring scheduled capital repayments, which are usually the larger cash cost.
- Sizing debt against a peak year of earnings rather than a normalised figure, so the structure only works if the best year repeats.
- Assuming a covenant breach means the loan is called in, when in most cases it triggers renegotiation on worse terms.
Questions
People also ask.
How much acquisition debt will a lender provide?
Commonly two to four times EBITDA for a stable mid market business, with less for cyclical or customer concentrated targets.
Is acquisition debt secured on the target or the buyer?
Usually on the target's assets and shares, though smaller deals frequently also require personal guarantees from the buyer.
Does acquisition debt reduce tax?
Interest is generally deductible, but many countries now cap the deduction at a percentage of taxable earnings, which limits the benefit on aggressive structures.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related