Securing Capital for Lower Middle Market Companies

Securing Capital for Lower Middle Market Companies

Securing Capital for Lower Middle Market Companies

Lower middle market companies sit in the hardest spot: too large for small-business products, not big enough to pull cheap institutional money on name alone. Capital is available, but it goes to firms that show control over cash, clean reporting, and a credible use of funds. This is the playbook that gets deals approved.

Quick take: approvals follow clarity and control. Present a tight model with believable margins, a use-of-funds that actually drives cash, collateral the lender can control, and a reporting cadence they can trust. Borrow what you can repay from base-case cash flow, not the best case. Get the legal and operational mechanics right first; pricing improves after lenders see discipline.

Contents

What “Lower Middle Market” Means

We’re talking about companies with roughly $10–$150 million in revenue and $2–$20 million in EBITDA. You have real customers, real operations, and real variance month to month. Banks want stable, predictable cash. Funds want a clear path to repayment with covenants they can monitor. If you cannot show that path, you will pay up or be declined.

Product Use Case Sizing & Leverage Key Controls
Senior Term Loan / RCF Growth capex, tuck-in M&A, refinancing 2.0x–3.5x Net Debt / EBITDA typically Financial covenants, negative pledge, reporting
Asset-Based Lending (ABL) Working capital against AR/inventory AR 80–90%; inventory 40–60% eligible Borrowing base, dominion of funds, field exams
Receivables Purchase / Factoring Faster cash conversion, seasonality Up to 90% advance on approved debtors Notice to payer, concentration caps, recourse terms
Trade Finance (LCs, PO Finance, Inventory-in-Transit) Import/export of physical goods Short tenor, self-liquidating Title control, blocked collections, insurance
Equipment Finance / Leasing Machines, vehicles, technology Loan-to-value 70–90% on new assets Asset liens, maintenance covenants, insurance
Mezzanine / Unitranche Stretch leverage, acquisitions, recap Total 3.5x–5.0x+ Net Debt / EBITDA PIK or cash pay, incurrence tests, warrants possible
Minority Equity / Preferred Scale-up, balance sheet repair Dilution instead of leverage Board rights, dividends, protective provisions

Credit Metrics Lenders Actually Use

  • Net Debt / EBITDA: base-case leverage target, not peak-cycle EBITDA. Many lenders cap 3.0x–3.5x without strong collateral.
  • Fixed-Charge Coverage (FCCR): EBITDA less capex and cash taxes divided by fixed charges. >1.2x is a line in the sand for many senior lenders.
  • Interest Coverage: EBITDA / cash interest. Healthy starts at ~3.0x and up.
  • Working Capital Turns: AR days, inventory days, AP days; lenders hate surprises in these trends.
  • Customer Concentration: any buyer >20% of sales needs a plan: contracts, credit insurance, or help from a confirmer.
  • Quality of Earnings: one-offs stripped out, revenue recognition policy explained, backlog validated.

Documents You Need — Data Room Checklist

Item What It Should Show
Audited financials (3 years) + YTD Clean revenue recognition, margin trends, covenant history
Monthly management accounts (24 months) Consistency with audits, variance analysis, working capital metrics
12–36 month model (base, downside) Cash conversion, debt service, sensitivity to volume/price/FX
AR and AP agings; inventory reports Eligible vs. ineligible, concentrations, slow movers, obsolete stock policy
Customer and supplier top-20 lists Contracts, terms, credit limits, churn/renewal rates
Legal package Corporate chart, liens, litigation, IP, permits, leases
Use-of-funds memo What you will buy, when cash returns, and how it pays the debt

How to Structure the Ask

Match product to cash flows. If the asset throws off cash quickly, use short-dated facilities that revolve. If it’s a multi-year payoff, accept covenants and price that reflect duration.

  • Stage disbursements: draw in tranches against milestones; it lowers risk and can tighten pricing.
  • Blend facilities: ABL for working capital plus a smaller term loan for capex beats one oversized line.
  • Waterfall the cash: collections go to a controlled account; the lender sweeps; excess returns to you. This wins approvals.
  • Downside plan: show actions you take if EBITDA drops 15–20%: freeze hires, cut capex, adjust inventory.
  • Covenant candor: negotiate headroom you can live with and reporting you can deliver on time, every time.

Collateral Lenders Respect

Not all collateral is equal. Lenders care about control and liquidation value, not sticker price.

Collateral What Works What Doesn’t
Receivables Notice to payer, low disputes, predictable terms Heavily concentrated, aging beyond 90 days, side letters
Inventory Identifiable SKUs, insured, controlled locations Obsolete stock, consignment confusion, weak counts
Equipment Serialised assets, service records, resale market Custom builds with poor secondary value
Contracts Assignable, long-tenor, strong counterparties Non-assignable, cancellable at will

Typical Timeline and Process

  1. Week 0–1: Readiness check. Lock the model, assemble the data room, align management.
  2. Week 2–3: Market sounding. Shortlist lenders by product fit; no mass blasts. Share a lender-grade teaser and get soft feedback.
  3. Week 3–5: First-round submissions. Release NDA, send full pack, run Q&A fast. Consistency wins.
  4. Week 5–7: Term sheets. Compare size, price, covenants, reporting, and fees. Push for meaningful points, not vanity items.
  5. Week 7–10: Confirmatory diligence. Field exam, legal diligence, collateral checks. Keep responses tight and documented.
  6. Week 10–12: Closing. Final documents, conditions precedent, first draw mechanics.

Common Mistakes That Kill Deals

  • Pitching best-case numbers and hiding volatility; lenders underwrite the base case.
  • Asking for a single oversized line instead of a blended solution.
  • Weak cash control — collections into operating accounts with no waterfall.
  • Messy AR and inventory reporting; no clean aging or counts.
  • Late answers and moving targets during diligence.
  • Ignoring tax, legal, or lien issues until the last mile.

A Straightforward Playbook

  1. Define the use of funds. Tie every dollar to an outcome that improves cash generation.
  2. Build a lender-grade model. Base and downside, with drivers that match how the business actually runs.
  3. Clean the working capital data. AR/AP agings and inventory that reconcile to the ledger.
  4. Choose the right products. ABL or receivables purchase for working capital; term debt for capex; trade finance for physical flows; mezzanine or minority equity for stretch.
  5. Set controls upfront. Blocked collections, borrowing base, inspection, and insurance. This is non-negotiable for better pricing.
  6. Engage targeted counterparties. Pick lenders that actually write your ticket size in your sector.
  7. Respond fast and consistently. One source of truth, one owner for the data room, deadline discipline.
If you need a lender-ready pack, we can build the model, assemble the data room, and run a structured outreach to counterparties that fund your size and sector. No noise — just a clean process designed to clear credit committees.

FAQ

What’s a realistic leverage range?

For senior debt, expect 2.0x–3.5x Net Debt / EBITDA if cash flows are stable and reporting is solid. Higher leverage requires stronger collateral or a mezzanine layer that prices the extra risk.

How do I lower pricing?

Improve visibility and control: borrowing base with weekly certificates, blocked collections, covenant headroom, and audited statements. Lenders price to risk and effort. Make both easier.

What if I have customer concentration?

Use credit insurance, confirmations, or longer-term contracts with clear claims mechanics. Cap exposure by debtor and show alternates in the pipeline. Do not ask the lender to ignore concentration; manage it.

Is equity always a last resort?

Not if leverage would strain cash. Minority equity or preferred can stabilize the balance sheet and unlock cheaper senior lines. Over-borrowing is more expensive in the end.

This article is general information for corporate readers. Requirements vary by jurisdiction, sector, and lender. Always verify current standards with legal, tax, and banking advisers.

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