Find Me Funders
Leverage Ratio
Also called debt to equity, debt to tangible net worth, funded debt to EBITDA, gearing.
Any of several ratios measuring how much of the business is funded by debt rather than owner capital, most often total liabilities to tangible net worth or funded debt to EBITDA.
Drafted with AI assistance. Not yet independently checked. Nobody has verified the claims on this page against a source, so treat the figures and legal points as a starting point rather than as settled, and confirm anything you are about to act on. How we check things.
What it means
Two families of measure, answering two different questions.
Where you meet it
In a bank term sheet as a maximum, tested quarterly or annually off compiled or reviewed financials. In SBA and conventional credit memos. At renewal, where a ratio that has drifted is the reason a line is reduced. And in a subordination discussion, where whether owner debt counts as debt or as equity decides the outcome.
The definitions in your covenant are not the textbook ones
Read how the agreement defines each term. Does "debt" include subordinated shareholder loans, capital and operating leases, contingent obligations, or amounts owed under receivable-purchase agreements? Does "tangible net worth" deduct loans to officers and related parties as well as intangibles? Those definitions were drafted by the lender, and they are where the ratio is actually decided.
Where this one catches people
Three ways a business breaches a leverage covenant without doing anything wrong.
An acquisition adds goodwill, which is deducted from tangible net worth, so a deal that improves earnings can worsen the balance-sheet ratio the day it closes. A change in lease accounting brings obligations onto the balance sheet that were previously disclosed in a note, and a covenant written before that change now captures them. And a distribution to owners for tax reduces equity, which raises the ratio, in the same quarter the profit that caused the tax bill raised nothing else.
On the other side is the ratio's blind spot. Short-term funding documented as a purchase of future receivables may not appear as debt on your balance sheet at all, so a business can be running heavy fixed daily remittances and show modest leverage. The cash still leaves. If you are testing whether you can carry more, do the arithmetic on the payments, not on the ratio.
Worked through
Illustrative only.
Total liabilities $1,400,000. Equity $600,000, of which $150,000 is goodwill from an earlier acquisition.
Tangible net worth = 600,000 − 150,000 = $450,000.
Debt to tangible net worth = 1,400,000 ÷ 450,000 = 3.11 times. A covenant capping the ratio at 3.00 times is breached, though no payment was missed.
Separately, funded debt (excluding trade payables) is $900,000 and trailing twelve months EBITDA is $260,000.
Funded debt to EBITDA = 900,000 ÷ 260,000 = 3.46 times.
Now suppose the owners take a $75,000 tax distribution. Equity falls to $525,000, tangible net worth to $375,000, and the first ratio moves to 1,400,000 ÷ 375,000 = 3.73 times, with nothing about the operating business having changed.
Figures in the example are illustrative. They show the arithmetic, not a quote — what any one lender would charge is on that lender's page, where it is published at all.
Where you will meet this term
Read next
Leverage Ratio — common questions
What does leverage ratio mean?
Any of several ratios measuring how much of the business is funded by debt rather than owner capital, most often total liabilities to tangible net worth or funded debt to EBITDA.
Where does leverage ratio catch people out?
Three ways a business breaches a leverage covenant without doing anything wrong.
Is leverage ratio the same as an interest rate?
Leverage Ratio is defined above; if you are comparing it against a rate, check whether the two measures share a time dimension before you put them side by side.
Which products does leverage ratio apply to?
Term Loan, Business Line of Credit, SBA Loan, Asset-Based Lending.
Is there a worked example of leverage ratio?
Yes, on this page, and it is labelled illustrative. It shows the arithmetic, not a quote from any lender.
What else should I read alongside leverage ratio?
Altman Z-Score, Covenant, Current ratio, Debt schedule, Debt service coverage ratio.
Has this definition been checked?
Not yet. This entry is drafted and live, and the notice at the top says so. Confirm anything you are about to act on.
Is this legal advice?
No. It is a definition. What a clause does in your contract, in your state, is a question for a lawyer licensed where you are.
Can I suggest a term?
Yes — [email protected]. The glossary grows from what people are actually shown in contracts.