SaaS / Recurring Revenue LBO

Step 1: EBITDA-Based Debt Capacity

Debt Capacity = Maximum Total Leverage × EBITDA

Debt Capacity = 5.5x × $7.5m = $41.3m

This is the debt ceiling implied by a conventional EBITDA leverage test — the multiple most sponsors and lenders quote first. But for a SaaS business with a thin 15.0% (0.15) EBITDA margin, an EBITDA-based ceiling can understate what the recurring, contracted revenue base could actually support, which is why it's only the first of three tests.

Step 2: Interest Coverage-Based Debt Capacity

Maximum Interest Expense = EBITDA / Minimum Interest Coverage Ratio

Maximum Interest Expense = $7.5m / 3.0x = $2.5m

Maximum Debt = Maximum Interest Expense / Cost of Debt

Maximum Debt = $2.5m / 7.0% (0.07) = $35.7m

The interest coverage covenant caps the debt load at the level where interest expense alone consumes no more than one-third of EBITDA. For thinner-margin SaaS targets, this coverage test frequently ends up more restrictive than the headline leverage multiple — exactly what happens here.

Step 3: Entry Enterprise Value, Effective Debt Capacity, and Sponsor Equity Check

Entry Enterprise Value = Entry EV / ARR Multiple × ARR

Entry Enterprise Value = 6.0x × $50.0m = $300.0m

Effective Debt Capacity = MIN($41.3m, $35.7m) = $35.7m

The interest coverage test binds, not the leverage guideline — the lender's real constraint is $35.7m, about 4.8x EBITDA, well inside the 5.5x headline multiple.

Sponsor Equity Check = $300.0m − $35.7m = $264.3m

Note how little of this $300.0m purchase price is funded with debt (about 12%) — because the deal is priced on a revenue multiple (6.0x ARR, roughly 40x the current EBITDA), leverage does far less of the work here than in a traditional industrial LBO, and the sponsor's return depends much more heavily on ARR growth and the exit multiple holding up.

Step 4: Exit Equity Value and Multiple of Money — Base Case vs. Downside Case

Using the assumptions above, exit ARR, exit enterprise value, exit equity value, and multiple of money are computed for both scenarios:

The spread between these two outcomes is the core lesson of a recurring-revenue LBO: because the entry price is set on a revenue multiple against thin current profitability, the deal's economics are dominated by whether NRR (and the multiple the market is willing to pay for it) holds up — not by leverage or margin expansion, which drive returns in a traditional industrial buyout. A 15-point drop in NRR here turns a solid 2.15x return into a loss of capital, even though the debt structure never changes.

Final Results

• Effective Debt Capacity: $35.7m (binding constraint: interest coverage, not the 5.5x leverage guideline)
• Sponsor Equity Check: $264.3m
• Base Case MoM / IRR: 2.15x / ~16.5%
• Downside Case MoM / IRR: 0.72x / ~-6.5%

This kind of sensitivity analysis is exactly what a sponsor would run before committing capital — pairing the debt capacity work with a range of NRR and exit-multiple scenarios to understand how much of the projected return depends on growth assumptions holding up, versus how much is protected by the capital structure.

Would you like to explore how the base case return changes if the sponsor also assumes 10% (0.10) of net-new ARR growth on top of NRR-driven expansion?