What is a good debt-to-EBITDA ratio?

The higher a company’s debt-to-EBITDA ratio, the more debt it carries relative to earnings and the longer it would likely take to pay off that debt.

On average, across industries, midsize businesses typically target a maximum debt-to-EBITDA ratio between 2.5 to 4, Beckner said. But healthy ratios vary by industry and depend on your company’s goals.  

A company in a highly cyclical industry may prefer a lower debt-to-EBITDA ratio so it can comfortably navigate its debt obligations during a downturn. Typical capital expenditures are also a factor. 

“If you have significant capital expenditures every year to update machinery, you may not have as much free cash flow to pay down debt,” Beckner said. “Whereas a firm with high margins and lots of free cash flow may be comfortable with a higher debt-to-EBITDA ratio.” 

Business goals matter, too. If your company needs additional capital to accelerate growth, you can choose between two sources: 

• Equity financing doesn’t affect your debt-to-EBITDA ratio but dilutes ownership permanently. While investors may accept lower immediate returns than lenders, you’re giving up a share of future profits and control. Contributing your own equity preserves ownership but comes with opportunity costs. 
• Debt financing increases your debt-to-EBITDA ratio and requires regular interest payments that consume cash flow, but you retain ownership and can deduct interest expenses. 

“It comes down to an ownership decision about what’s the best way to balance growth trajectory, cash flow and cost of capital,” Beckner said. 

Your company’s ideal ratio can also shift over time, temporarily rising while borrowing funds for a transformative investment before returning to a long-term target. 

Benchmarking your company’s debt-to-EBITDA ratio against competitors can help you assess what’s healthy. Your banker can help you understand typical maximum and long-term debt-to-EBITDA ratios in your industry. 

How debt-to-EBITDA influences borrowing capacity

When a company applies for a commercial loan, debt-to-EBITDA is one factor lenders consider in determining its debt capacity. But it isn’t the only or most significant factor. Lenders include metrics that capture things the debt-to-EBITDA ratio leaves out, such as capital expenditures or other cash outflows, as well as business factors beyond the numbers. 

“We’re focused on the ownership and C-suite team’s track record, whether they’re in an industry we feel is sustainable and how concentrated their customers and suppliers are,” Beckner said. “There are so many qualitative factors that are just as important as quantitative metrics.” 

Debt-to-EBITDA benchmarks can also vary by financing type. Lenders may prefer lower debt-to-EBITDA ratios on commercial loans based primarily on the company’s ability to generate cash flow without sufficient assets to collateralize the loan. Other options may include:  

• Asset-based lending and mortgages: Lenders may be comfortable with higher debt-to-EBITDA ratios on loans secured by assets such as accounts receivable, inventory or real estate. “If your debt-to-EBITDA is creeping up to a level that may not be sustainable, talk to your banker about alternative types of financing that can support that level of leverage until you can bring it to a more manageable level,” Beckner said. 
• Direct lending: Fast-growing companies planning major acquisitions may benefit from direct lending. “They do extensive due diligence on the enterprise value and cash flow generation and may be able to get comfortable with a higher ratio along with a different cost of capital,” Beckner said. 

Your banker can help you understand how different financing options will affect your company’s cash flow. 

“It’s all about understanding the art of the possible and how those options can support your company’s goals,” Beckner said.