Building a Defensible Adjusted EBITDA for a Leveraged Financing
Meridian Industrial reports trailing-twelve-month EBITDA of $48.2 million. The figure includes a $6.5 million litigation settlement gain, $3.1 million of restructuring charges, and $4.0 million of stock-based compensation. A customer representing 18% of revenue and $2.8 million of EBITDA notified Meridian in month 11 that it will not renew. Meridian closed the Ridgeline acquisition in month 7; Ridgeline contributed $5.0 million of EBITDA in the period and $9.0 million on a full-year standalone basis. The proposed financing is a $225 million term loan plus a $40 million undrawn revolver, with a maximum total leverage covenant of 4.50x tested pro forma, and the credit agreement permits acquisition add-backs. Cash on hand is $15 million. Meridian has two years of audited financials plus a six-month interim period that is reviewed, not audited.
1. Build the adjusted EBITDA the arranger should actually credit. Identify each adjustment, say whether it is defensible, and produce a range.
Read the worked answer
Start from reported EBITDA and strip out what a lender will not underwrite.
| Step | $M | Rationale |
|---|---|---|
| Reported TTM EBITDA | 48.2 | |
| Less litigation settlement gain | (6.5) | Non-operating and non-recurring; normally excluded from the credit agreement definition |
| Add restructuring charges | 3.1 | Permitted only if cash and genuinely finished; confirm no further programs in the projections |
| Less lost customer | (2.8) | EBITDA that will not recur; lenders remove this almost automatically |
| Subtotal | 42.0 | |
| Stock-based compensation | 0 to +4.0 | Contested; conservative lenders cap or disallow the add-back |
| Pro forma Ridgeline | +4.0 | $9.0M full-year less $5.0M already in TTM; permitted if documented |
| Adjusted EBITDA | 46.0 – 50.0 |
The underwriting case is $46.0 million. Do not present $50.0 million as the base case unless the SBC add-back is negotiated and the acquisition run-rate is verified.
2. Compute total leverage at each end of the range and determine whether the 4.50x covenant is satisfied at closing. What is the maximum debt the business can support?
Read the worked answer
Use the same EBITDA the covenant credits.
- $225M / $46.0M = 4.89x gross; net debt $210M / $46.0M = 4.57x
- $225M / $50.0M = 4.50x gross; $210M / $50.0M = 4.20x
On the conservative case the deal breaches at close. It clears only if the arranger accepts the SBC add-back and the full acquisition run-rate at the same time, which is the combination a credit committee is least likely to grant.
Capacity at 4.50x: $207M on $46.0M, $225M on $50.0M. With a normal 25–35% cushion, size to 4.00x or below: 4.00 x $46.0M = $184M.
Recommendation: cut the term loan to roughly $185M, or structure a delayed-draw tranche conditioned on a quality-of-earnings verification of the Ridgeline run-rate. A $225M commitment priced off $50M of EBITDA is a covenant breach waiting for the first quarter.
3. What data-quality issues must be resolved before the credit committee can rely on this EBITDA, and how would you handle the unaudited stub and the customer concentration?
Read the worked answer
Four gaps, each with a fix:
- Tenor of financials. Two audited years plus a reviewed stub is thin for a leveraged deal. Commission an independent quality-of-earnings report; lenders will want the stub agreed to the trial balance and to the audited annuals.
- Support for add-backs. The settlement gain and restructuring must be documented line by line. The QoE should test whether the restructuring is complete or recurring.
- Ridgeline significance. Run the Regulation S-X Rule 3-05/Article 11 significance tests. If the acquisition exceeds 20% on any test, separate audited financials and pro forma financial information are required in the materials, not just a management schedule.
- Customer concentration. At 18% of revenue and $2.8M of EBITDA, run a downside case with the customer removed and disclose it in the MD&A and covenant certificate.
The TTM must be built from audited annuals plus the reviewed stub and must foot; every add-back goes on a schedule the bank can independently re-perform.