Capitalized Software Costs: How Lenders Adjust EBITDA
Capitalized software costs are one of the most frequent sources of disagreement between healthcare software owners and the lenders reviewing their financials. When a company records part of its development spending as an asset rather than an expense, reported EBITDA can rise even though the cash has already left the business.
Lenders know this, and many adjust earnings before deciding how much they can lend. This article explains what capitalization is, why it matters to lenders and how owners and buyers can prepare. Accounting treatment depends on the company’s circumstances and applicable standards, and nothing here is accounting, tax or legal advice. Owners should work with their accountants.
What Capitalization Means
When a software company pays developers to build or improve its product, some of that spending may qualify to be recorded on the balance sheet as an asset instead of as an expense in the current period. The asset is then amortized over its expected useful life.
The effect on the income statement is significant:
- Operating expenses appear lower in the year the work is done
- EBITDA appears higher, because amortization is excluded from EBITDA
- Cash flow is unchanged, because the developers were still paid
Capitalization can be appropriate accounting, but it changes how earnings look.
Why Capitalized Software Costs Matter to Lenders
Lenders size loans based on the cash a business generates to cover debt payments. If EBITDA includes the benefit of capitalized development spending, it may overstate the cash available.
Lenders typically ask whether development spending is a recurring cost of staying competitive. In healthcare software, the answer is often yes. Products must be updated for security, integrations, payer and regulatory changes and client requests. If that spending will continue every year, many lenders treat it as an operating cost, regardless of how it is recorded.
How Lenders May Adjust EBITDA
Approaches vary by lender, but adjustments may include:
- Subtracting capitalized development: treating the amount capitalized each year as an expense when calculating cash flow
- Separating maintenance from growth: distinguishing spending needed to maintain the product from spending on new features
- Reviewing trends: comparing capitalized amounts across several years to see whether they are rising
- Considering deferred revenue: looking at how billing timing affects reported revenue and cash
The adjusted figure is then used to measure debt coverage. A lower adjusted EBITDA can mean a smaller loan, a different structure or additional equity from the buyer.
Impact on Acquisitions
Capitalization matters on both sides of a deal. A seller may present EBITDA that includes the benefit of capitalized costs and ask for a price based on that figure. A buyer relying on acquisition financing may find that the lender sizes the loan on a lower adjusted number, leaving a gap between the price and the available debt.
Buyers evaluating a software target should identify capitalized costs early. Our article on health tech acquisition due diligence covers the financial and contract review buyers typically perform. Buyers considering SBA-backed financing may also find our article on whether you can buy with a healthcare software company SBA loan useful.
Impact on Valuation
Buyers who apply valuation multiples to adjusted earnings may arrive at a different value than a seller who uses reported EBITDA. Understanding how the market views development spending can help owners set realistic expectations. Our overview of health IT valuation multiples discusses what drives value across the sector.
An Illustration Without the Math
Consider two healthcare software companies with the same revenue, the same development team and the same cash in the bank at year end. One expenses all of its development spending. The other capitalizes a meaningful share of it. The second company will report higher EBITDA, even though the two businesses produced the same cash.
A lender that adjusts for capitalization will view the two companies similarly. A buyer or owner who relies only on reported EBITDA may conclude that the second company can support more debt or deserves a higher price, which can lead to frustration when underwriting begins.
How Owners Can Prepare
Owners planning to borrow or sell can reduce surprises by:
- Tracking development spending clearly, including what is capitalized and why
- Separating maintenance work from new product development in records
- Presenting both reported and adjusted earnings to lenders
- Explaining how development spending supports retention and growth
- Working with accountants to confirm the capitalization policy is consistent and documented
Transparency tends to build credibility. A lender that sees owners already accounting for capitalized software costs may be more comfortable with the rest of the financial picture.
Loan Options for Software Companies
Software companies have limited hard collateral, so lenders rely heavily on cash flow. Options may include conventional loans underwritten on earnings and owner strength, and SBA 7(a) loans for eligible businesses and uses. Eligibility and terms depend on the business, the borrower, the use of proceeds, program rules and lender review. Every loan is subject to approval, and nothing here is a commitment to lend.
For more on how lenders approach asset-light borrowers, see our guide to loans for software companies without hard collateral.
Mistakes to Avoid
- Presenting reported EBITDA without explaining capitalized amounts
- Pricing an acquisition on earnings that a lender will not accept
- Changing capitalization policy shortly before a sale or loan request
- Assuming development spending will decline after closing
Final Thoughts
Capitalized software costs can make a healthcare software company look more profitable than its cash flow supports. Lenders often adjust for this, which can affect loan size, deal structure and valuation. Owners and buyers who understand the adjustment early can set realistic expectations and prepare stronger financing requests.
US Medical Funding helps healthcare technology companies and buyers finance acquisitions, growth and working capital. Learn more about our healthcare technology financing options.
