Funded debt is the borrowed money a credit agreement counts when it measures leverage: debt that carries interest or was used to fund the business. It usually includes term loans, the drawn balance of a revolving line, finance (capital) leases, seller notes and subordinated notes. It usually excludes trade payables, accrued expenses, undrawn commitments and operating leases. The exact list is in the agreement's definitions section, and gray items such as seller notes, shareholder loans and cash netting can move the ratio by a full turn of EBITDA.
- What it is
- The debt a leverage covenant counts, as defined in the credit agreement
- Usually in
- Term loans, drawn revolver, finance leases, seller and subordinated notes
- Usually out
- Trade payables, accruals, undrawn lines, operating leases
- Gray areas
- Standby seller notes, shareholder loans, earnouts, cash netting
- Where it is used
- Total and senior leverage covenants, pricing grids, sizing at underwriting
Where funded debt shows up
Funded debt is the numerator of the most common cash-flow covenant, the total leverage ratio: funded debt divided by EBITDA for the trailing twelve months. A senior leverage ratio uses only the funded debt that ranks first, and a leverage-based pricing grid uses the same number to set the interest margin each quarter. When a lender sizes a loan, it is solving the same equation backwards: how much funded debt the EBITDA will carry.
That makes the definition worth reading before the term sheet is signed, not after the first compliance certificate is due. Most owners focus on the covenant level. The definition of the numerator does as much work, and it is negotiated far less often.
The covenant level is the number everyone reads. The definition of funded debt is the number that decides whether you pass.
What is usually counted, and what is not
Credit agreements differ, but most definitions follow the same logic: count obligations that were borrowed or that finance long-lived assets, and leave out obligations that arise from running the business day to day.
| Item | Usual treatment | Why |
|---|---|---|
| Senior term loans, including the current portion | In | Borrowed money; the core of the ratio |
| Revolving line, drawn balance | In | Borrowed money, even if it is repaid and redrawn |
| Revolving line, undrawn commitment | Out | Nothing has been borrowed yet |
| Finance (capital) leases and equipment loans | In | They finance assets the way a loan would |
| Seller notes and subordinated notes | In for total leverage; out for senior leverage | Borrowed money, but ranked behind the senior lender |
| Operating leases | Usually out | Rent for the use of an asset; many agreements exclude them even though they now appear on the balance sheet |
| Trade payables and accrued expenses | Out | Ordinary operating obligations, not financing |
| Letters of credit | Drawn amounts in; undrawn often out | A drawn letter of credit becomes a reimbursement obligation |
| Guarantees of someone else's debt | Often in | The company is on the hook if the other party does not pay |
| Earnouts and deferred purchase price | Varies: often in once fixed and payable | A contingent amount is not yet a debt; a fixed one is |
| Loans from shareholders | Varies: often out if fully subordinated | The lender may treat deeply subordinated owner money as quasi-equity |
Two items cause the most surprises. The first is the merchant cash advance. It is sold as a purchase of future receivables rather than a loan, but underwriters almost always count the outstanding balance as debt, and most would rather it were gone at closing; see refinancing merchant cash advances into term debt. The second is the operating lease. Since lease accounting changed, operating leases sit on the balance sheet as a liability. Most agreements keep them out of funded debt anyway, either by excluding them by name or by fixing the accounting rules as they stood when the loan was made. If yours does neither, a new facility lease could push you toward a breach without a dollar being borrowed.
How the definition moves the ratio a full turn
Take a company with trailing EBITDA of 2,000. Its balance sheet carries a senior term loan of 4,000, a revolver drawn to 1,000 at quarter-end, equipment finance leases of 500, a seller note of 1,000 from an acquisition two years ago, and an operating lease liability of 1,500 for its building.
| Definition | Funded debt | Leverage (times EBITDA) |
|---|---|---|
| Senior term loan and finance leases only | 4,500 | 2.25 |
| Plus the drawn revolver (senior leverage) | 5,500 | 2.75 |
| Plus the seller note (total leverage) | 6,500 | 3.25 |
| Plus the operating lease liability | 8,000 | 4.0 |
The same company, on one balance-sheet date, is anywhere from 2.25 to 4.0 times levered depending on which lines the definition picks up. Between the narrowest reasonable reading and the usual total-leverage reading there is a full turn of EBITDA. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA, so a turn is often the whole difference between comfortable headroom and a covenant breach.
The revolver line deserves a second look. The balance is measured on the test date, so a company that draws its line to pay suppliers just before quarter-end reports more funded debt than one that draws a week later. Some agreements use the average drawn balance over the quarter, which removes the timing effect. If your business is seasonal and the quarter-end falls at a peak, raise it during negotiation; see covenant headroom.
The gray areas worth negotiating
- Seller notes on standby. A seller note that receives no payments while the senior loan is outstanding, as on full standby, is still owed. Senior lenders usually leave it out of senior leverage; whether it sits in total leverage is a negotiating point. The subordination terms the lender requires often decide how it is counted.
- Cash netting. A net funded debt definition subtracts cash on hand, usually unrestricted cash in accounts the lender controls, and often only up to a cap. It rewards a company that holds cash rather than paying down a revolver it may need again.
- Shareholder loans. Money an owner lent the company can be excluded if it is fully subordinated and cannot be repaid while the loan is outstanding. Lenders want the subordination in writing before they will treat it that way.
- Earnouts. Many agreements count an earnout only once it is earned and payable. If the definition counts the full potential amount from day one, the ratio starts higher than the economics justify; see how earnouts interact with acquisition debt.
- Equipment debt at a subsidiary or with another lender. It counts, even though it sits outside the main facility. Lenders care about everything the company owes; see equipment financing alongside a senior facility.
Each of these is decided in the definitions section, not in the covenant itself. A lender that agrees to a higher covenant level but a broader definition may have given nothing away.
How to prepare your numbers
Start with a complete business debt schedule: every loan, lease, note and advance, with the lender, balance, payment, rate, maturity and collateral. Then mark each line as in or out under the definition you expect, and run the ratio both ways. If the answer changes whether you pass, you have found the part of the term sheet that needs attention.
When Transparent prepares a lender package, the financing model carries the debt schedule and computes both senior and total leverage on the lender's likely definition, so the question is settled before a lender raises it. The EBITDA side matters just as much; see how EBITDA is defined in a credit agreement.
Common questions
- Is funded debt the same as total liabilities?
- No. Total liabilities include trade payables, accrued wages, deferred revenue and taxes owed. Funded debt is a narrower subset: money borrowed, plus obligations that finance assets the way a loan would.
- Does an undrawn line of credit count as funded debt?
- Usually not. Only the drawn balance counts. Some agreements look at the average drawn balance over the quarter rather than the balance on the test date.
- Are seller notes funded debt?
- Usually yes for total leverage and no for senior leverage. A seller note on full standby is still owed, so whether it is counted is set by the credit agreement and the subordination agreement.
- Do operating leases count after the lease accounting change?
- Most credit agreements exclude them, either expressly or by fixing the accounting rules at the date of the loan. Check your agreement, because a broad definition could count a new building lease.
- Is a merchant cash advance funded debt?
- Lenders almost always treat the outstanding balance as debt when they underwrite, whatever the advance contract calls it, and most want it repaid at or before closing.