Senior leverage is senior debt divided by EBITDA: the revolver, the senior term loan and anything else ranked first for repayment. Total leverage is all funded debt divided by the same EBITDA, adding seller notes, mezzanine and other junior loans and, in the lender's view, holding company debt. The senior lender caps senior leverage to protect its place at the front of the line, and usually caps total leverage too, because junior debt competes for the same cash. Junior lenders set their own, looser total leverage limit. A deal must pass both.
- Senior leverage
- Senior debt ÷ EBITDA
- Total leverage
- All funded debt ÷ EBITDA
- In total but not senior
- Seller notes, mezzanine, holdco debt; second-lien depends on the definition
- Common senior range
- Senior cash-flow lenders commonly lend 2x to 3.5x EBITDA
- Who tests which
- Senior lender: usually both; junior lender: total, with a cushion
Two ratios over the same earnings
Both ratios divide debt by EBITDA, and both usually measure EBITDA over the last twelve months as the credit agreement defines it, adjustments included; see how EBITDA is defined in a credit agreement and LTM. What differs is the numerator.
Senior leverage counts the debt that gets paid first: the drawn revolver, the senior term loan, and other debt ranked equally with them. Total leverage counts every dollar of funded debt, senior and junior alike. The gap between the two ratios is the junior capital in the structure. In a company with only a bank loan, the two are the same number. Add a seller note and they separate.
Some agreements measure a third ratio, first-lien leverage, which excludes second-lien debt that a senior secured ratio would include, and some measure leverage net of cash. The names vary more than the ideas. What matters is the definition in the document, which is why the definitions section of a credit agreement repays careful reading.
What counts where
| Debt | In senior leverage? | In total leverage? | Notes |
|---|---|---|---|
| Revolver, drawn balance | Yes | Yes | Undrawn commitment usually excluded |
| Senior term loan | Yes | Yes | The core of the senior number |
| Unitranche loan | Yes, all of it | Yes | One loan covering senior and subordinated risk; see senior vs unitranche |
| Equipment loans and capital leases | Usually, as secured debt | Usually | Often forgotten until the first compliance certificate |
| Second-lien term loan | Depends on the definition: in a senior secured ratio, not in a first-lien one | Yes | See second lien loans |
| Mezzanine or subordinated notes | No | Yes | Junior in right of payment |
| Seller note | No | Usually | Some agreements exclude a fully subordinated note that pays nothing; many do not |
| Holding company debt | No | Not in the borrower's covenant, but in the lender's view | Paid from dividends the operating company sends up; see structural subordination |
| Earnout | No | Depends on the definition | Often counted only once earned and payable |
Two rows cause most surprises. Capital leases arrive with the business and sit outside the financing model until the compliance certificate counts them. Holding company debt sits outside the borrower's covenants entirely, which can make a structure look lighter than it is; lenders who see a holdco note that depends on the operating company's cash will count it in their own view of total leverage, whatever the covenant says. The choice of borrower is covered in holding company vs operating company as borrower.
A worked capital stack
Take an acquisition of a company with EBITDA of 1,000, at a price of 5,750 plus 250 of fees and costs. The buyer raises 6,000 in five layers:
| Source | Amount | Rank | Running senior debt | Running total debt |
|---|---|---|---|---|
| Revolver, drawn at closing | 250 | Senior | 250 | 250 |
| Senior term loan | 2,000 | Senior | 2,250 | 2,250 |
| Mezzanine notes | 750 | Subordinated | 2,250 | 3,000 |
| Seller note | 500 | Subordinated to both | 2,250 | 3,500 |
| Buyer's equity | 2,500 | Last | ||
| Total sources | 6,000 |
At closing, senior leverage is 2,250 over 1,000, or 2.25 times. Total leverage is 3,500 over 1,000, or 3.5x. The senior lender is near the low end of the range senior cash-flow lenders commonly lend to lower-middle-market companies, 2x to 3.5x EBITDA. The company as a whole is at the top of that range, carrying as much debt as the most aggressive senior lender would provide on its own.
Now suppose EBITDA falls from 1,000 to 800 in the second year, and the revolver is still drawn. Senior leverage becomes 2,250 over 800, about 2.8 times. Total leverage becomes 3,500 over 800, about 4.4 times. The senior lender's position is weaker but still covered by a large layer of junior capital and equity. The company, on the other hand, is carrying debt of more than four years of EBITDA, before a dollar of tax or capital spending, and the mezzanine lender's interest and the seller's note payments are coming out of the same shrunken cash flow as the senior loan's.
The same fall in earnings moves total leverage further than senior leverage, because it divides a larger stack of debt by the same shrinking earnings.
Why lenders cap each one separately
The senior lender's first concern is recovery. If the company fails, senior debt is repaid first from whatever the business or its assets fetch. Senior leverage tells the lender how much debt stands in front of the junior capital, and therefore how far the value of the business can fall before the senior loan is exposed. That is why the senior lender's own limit is on senior leverage.
But the senior lender cannot ignore the junior layers. Junior debt pays interest, often in cash, and every payment to the mezzanine lender or the seller is cash that did not go to the senior loan or into the business. A default on the junior debt can trigger a default under the senior agreement through a cross-default clause. And a company whose total leverage is high will struggle to refinance when the senior loan matures. So the senior agreement commonly caps total leverage as well, usually alongside a coverage test on all fixed charges; see DSCR vs FCCR.
The junior lender sets its own total leverage limit, deliberately looser than the senior lender's, so that the senior covenants trip first. That way the senior lender, which has the stronger claim, is the one that starts the conversation when things go wrong. How the two lenders' rights are ordered, including when junior payments can be blocked, is set in the intercreditor agreement; for seller notes, in a subordination agreement.
How the covenants are usually set
| Covenant | Which agreement | How it is typically set |
|---|---|---|
| Maximum senior leverage | Senior credit agreement | Off the lender's model case, with a cushion, often stepping down as the loan amortizes |
| Maximum total leverage | Senior credit agreement, often | Looser than senior, reflecting the junior layers at closing |
| Maximum total leverage | Mezzanine or second-lien agreement | Looser again, so the senior test trips first |
| Fixed charge or debt service coverage | Both agreements | Counts cash interest on every layer, senior and junior |
The cushion between the model and the covenant is the covenant headroom, and it matters more in a layered structure because the total leverage test has less room to absorb a bad year. A cure right, allowing owners to inject equity to fix a missed test, is worth negotiating on both. Leverage also drives price: many senior loans reprice by leverage tier on a pricing grid, so reducing senior leverage can lower the rate as well as widen headroom.
Seller notes, SBA loans and the standby exception
Seller notes are where owners most often misjudge the two ratios. In a conventional deal a seller note is junior debt: outside senior leverage, inside total leverage, and paying interest and principal from the same cash as the senior loan unless the senior lender restricts it. What terms a senior lender will accept is covered in seller note terms in non-SBA deals, and the trade-off against a mezzanine layer in mezzanine vs a larger seller note.
SBA loans are sized mainly on coverage rather than leverage. A seller note on full standby, with no principal or interest paid for the life of the SBA loan, adds nothing to debt service, and it can count for up to half of the required equity injection. A seller note that is not on standby is allowed, but it is debt: it counts in debt service, not toward the equity injection. Either way the note is still owed, and any lender measuring total leverage, including a conventional lender refinancing the business later, will count it. See full standby.
Managing both ratios after closing
- Pay down the senior debt first. Scheduled amortization and any excess cash flow sweep reduce senior leverage and total leverage together; paying junior debt early usually needs the senior lender's consent.
- Watch the revolver. A drawn line is senior debt the moment it is drawn, so a seasonal peak near a test date can move both ratios.
- Know how PIK interest counts. PIK interest is added to the principal instead of paid, so a junior note that pays in kind raises total leverage every quarter even while cash coverage looks comfortable.
- Model a bad year before signing. Run both ratios on the lender's downside case; the total leverage test is the one a layered structure breaks first.
Transparent's financing model carries the pro forma capitalization and the covenant tests for a proposed structure, so an owner can see which layer pushes the deal past a covenant before a term sheet is signed. For the definitions alone, see senior leverage ratio and total leverage ratio; for what the layers cost together, the cost of a layered capital stack.
Common questions
- Does a seller note count as leverage?
- In total leverage, usually yes. In senior leverage, no, because it is subordinated. Some credit agreements exclude a fully subordinated seller note that makes no payments; many do not, so check the definition of funded debt.
- Why would a senior lender care about total leverage if it gets paid first?
- Because junior debt draws on the same cash flow, a default on it can trigger a default on the senior loan, and a heavily indebted company is harder to refinance when the senior loan matures.
- Is unitranche counted as senior debt?
- Yes. A unitranche loan is one senior secured loan, so all of it counts in senior leverage, even the part that prices like subordinated debt. A first-out/last-out split between lenders does not change how the borrower's covenant counts it.
- Does the undrawn part of a revolver count?
- Usually not. Leverage covenants normally count only the drawn balance, though lenders look at the full commitment when they size the structure.
- Which ratio do lenders quote when they say they lend a multiple of EBITDA?
- A senior lender's range is senior leverage. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA; unitranche lenders stretch further, and junior capital can take total leverage above what any one senior lender would provide.