Middle-Market Capital Structure Planning

As companies grow, their financing needs often become more complex. A business may have a revolving line of credit for working capital, equipment loans for machinery, term debt from an acquisition, and additional capital requirements for expansion.

Each financing arrangement may serve a legitimate purpose. However, the combined obligations can create challenges involving debt service, collateral availability, lender covenants, and upcoming maturities.

Middle-market capital structure planning is the process of evaluating how a company's debt and equity are organized, whether the business can support its financing obligations, and how different capital sources affect liquidity, risk, and future growth.

For CFOs and business owners, the objective is not simply to obtain the largest possible loan. It is to establish a financing structure that matches the company's operating requirements and ability to generate cash.

Rainstar Capital Group is a national debt advisory firm that helps businesses explore commercial financing arrangements through its lending relationships.

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What Is a Capital Structure for a Middle-Market Company?

A company's capital structure is the combination of debt and equity used to finance its operations, assets, and investments.

For middle-market companies, this may include bank loans, private credit facilities, asset-based lending, equipment financing, subordinated debt, and shareholder equity.

There is no single universally accepted definition of a middle-market company. Financing providers may classify borrowers using revenue, EBITDA, enterprise value, or transaction size.

Debt Capital

Debt provides funding that the borrower must repay according to the financing agreement.

Debt may involve interest, fees, scheduled principal payments, collateral, guarantees, and financial covenants.

Different facilities can have different repayment priorities and restrictions.

Equity Capital

Equity represents ownership capital contributed by shareholders or investors.

Unlike conventional debt, equity generally does not require scheduled principal and interest payments. However, issuing new equity may dilute existing ownership or change governance rights.

Why the Balance Matters

A structure with excessive debt can place pressure on cash flow and increase refinancing risk.

A structure with insufficient financing may limit expansion or prevent the company from managing normal working capital requirements.

Capital structure planning considers both the cost of funding and the flexibility the company needs to operate.

Common Debt Financing Layers

Middle-market borrowers may use multiple forms of financing within the same capital structure.

Not every lender offers every structure, and not all layers of financing can be combined.

Senior Secured Debt

Senior secured lenders generally have priority rights over specified collateral relative to junior creditors, subject to the applicable documents and law.

A senior loan may offer a more predictable repayment structure, but it can restrict additional borrowing or asset transfers.

Revolving Working Capital Facilities

Revolving credit facilities can support inventory purchases, customer payment delays, and recurring operating expenses.

Asset-based revolving facilities may calculate availability using eligible accounts receivable and inventory.

Subordinated Debt

Subordinated debt generally ranks behind specified senior obligations in payment or enforcement priority.

It may help fill a financing gap in certain transactions, but its additional cost and contractual restrictions must be considered.

A junior financing arrangement cannot be added without addressing any restrictions imposed by existing senior creditors.

How to Evaluate Middle-Market Debt Capacity

Debt capacity is the amount of borrowing a company can reasonably support under its financial circumstances and a lender's underwriting requirements.

It is not determined by EBITDA alone.

Review Sustainable EBITDA

EBITDA is often used to compare operating earnings before interest, taxes, depreciation, and amortization.

However, EBITDA does not equal free cash flow.

CFOs should consider capital expenditures, working capital changes, taxes, and other cash requirements before drawing conclusions about borrowing capacity.

Lenders may also scrutinize proposed adjustments to EBITDA and exclude unsupported addbacks.

Calculate Leverage

A commonly used measure is:

Total Debt / EBITDA = Total Leverage Ratio

For example, a company with $12 million in total debt and $4 million in annual EBITDA has a simplified leverage ratio of 3.0x.

This indicates that debt equals three times annual EBITDA, but does not establish that the capital structure is appropriate.

Industry characteristics, cash flow stability, growth needs, collateral, and lender-defined adjustments all matter.

Evaluate Debt Service Coverage

A second measure compares cash available to meet debt obligations with required payments.

Debt Service Coverage Ratio = Cash Flow Available for Debt Service / Required Debt Service

A business can report substantial EBITDA yet face difficulty meeting payments because of capital expenditures, taxes, or seasonal working capital needs.

Lenders may use different calculations and financial thresholds.

Model Downside Conditions

A financing plan should be tested against plausible reductions in revenue, operating margins, or customer collections.

Stress testing helps management identify how quickly debt capacity and covenant headroom could deteriorate.

Hypothetical Middle-Market Capital Structure Example

Consider an established company with $35 million in annual revenue and $4 million in EBITDA.

The business has $12 million in outstanding debt and wants to invest in additional equipment while maintaining liquidity for operations.

Existing Financing Position

The company is considering an additional $2 million equipment investment.

If the full amount were borrowed without retiring existing debt, total debt would increase to $14 million.

Assuming EBITDA remained unchanged, leverage would rise to 3.5x.

Why the Calculation Is Only a Starting Point

The company must also evaluate the proposed equipment payment, post-capital-expenditure cash flow, existing loan maturities, and lender restrictions.

If the investment eventually improves earnings, projected leverage may decline. However, the improvement should not be treated as guaranteed before it occurs.

The figures are hypothetical and do not represent Rainstar lender requirements or an approved financing structure.

Match Financing Maturity to Business Needs

Capital structure planning includes determining when financing obligations must be repaid.

Long-Term Investments

Equipment purchases, acquisitions, and major facility improvements generally require an evaluation of financing that reflects the expected period of economic benefit.

Financing a long-lived asset with a very short repayment period can increase liquidity pressure.

Recurring Working Capital

Inventory and receivables requirements may fluctuate with sales and customer payment cycles.

A revolving facility may offer greater flexibility than repeatedly obtaining separate term loans, provided the business meets ongoing borrowing requirements.

Maturity Concentration

Maturity concentration occurs when several obligations become due within a relatively short period.

A company may have adequate current cash flow but still face substantial refinancing risk if multiple facilities mature simultaneously.

CFOs should prepare a debt maturity schedule and begin reviewing refinancing options before a major maturity becomes urgent.

Evaluate Financial Covenants and Operating Flexibility

Debt covenants are contractual requirements or restrictions that borrowers agree to follow.

They can influence financial planning long after the financing closes.

Leverage and Coverage Covenants

Some agreements establish maximum leverage ratios or minimum coverage requirements.

The exact calculation may differ from management's internal financial metrics.

A breach of covenant can create contractual consequences even when the company continues to make scheduled payments.

Restrictions on Additional Debt

Lenders may restrict additional borrowing, liens, acquisitions, distributions, or asset sales.

These restrictions can affect future growth projects and refinancing options.

Covenant Headroom

Covenant headroom measures how much financial performance can change before the borrower approaches a contractual threshold.

CFOs should forecast compliance using lender-defined calculations and plausible downside scenarios.

The Federal Reserve's leveraged lending guidance highlights sustainable capital structures, repayment capacity, stress scenarios, and covenant protections as important underwriting considerations.

Compare Bank Lending, Private Credit, and Asset-Based Financing

Middle-market borrowers may evaluate several financing sources, each with different underwriting priorities.

Bank Financing

Banks may consider operating history, financial performance, credit quality, collateral, and existing relationships.

Certain bank facilities can include financial covenants, guarantees, and ongoing reporting.

Private Credit

Private credit providers may offer financing structures designed around specific borrower circumstances, subject to their investment requirements.

Terms may involve negotiated pricing, fees, covenants, collateral, and prepayment provisions.

Private credit should not automatically be assumed more flexible or more expensive in every transaction.

Asset-Based Financing

Asset-based lenders emphasize eligible collateral and borrowing-base availability, alongside the borrower's financial condition.

These facilities may be relevant to businesses with substantial receivables or inventory.

However, borrowing availability can decline when eligible collateral decreases.

The best financing source depends on the borrower's circumstances rather than lender category alone.

How to Compare Middle-Market Financing Proposals

A financing proposal should be reviewed for its total economic and operational impact.

A proposal offering a lower interest margin may still be less suitable if it imposes substantial fees, restrictive covenants, or a maturity date that conflicts with the business plan.

Management should also review intercreditor arrangements when multiple lenders are involved.

When Should a Company Revisit Its Capital Structure?

A capital structure review can be useful before major financial changes occur.

Common triggers include an approaching loan maturity, a planned acquisition, significant equipment spending, declining covenant headroom, or increased working capital requirements.

A review may also be appropriate when a company's operating performance changes substantially or when its existing lender is unwilling to support additional borrowing.

The purpose is not necessarily to refinance every obligation.

Sometimes the existing structure remains appropriate, and the better decision is to maintain it while improving cash flow forecasting or liquidity management.

Documents for a Middle-Market Financing Review

CFOs preparing for a capital structure discussion should assemble:

• Historical and interim financial statements
• Current debt schedule and maturity profile
• Existing credit and security agreements
• Covenant compliance calculations
• Cash flow forecasts and operating budgets
• Accounts receivable and inventory reports, where relevant
• Capital expenditure plans
• Acquisition or expansion budgets
• Existing collateral and lien information
• Management's proposed financing objectives

Rainstar's published Capital Markets materials identify financial statements, debt schedules, bank statements, and other product-specific records as part of its financing documentation requirements.

Additional information may be needed depending on the transaction.

How Debt Advisory Supports Capital Structure Decisions

A debt advisory engagement may help management evaluate existing obligations, identify potential financing alternatives, and compare lender proposals.

For middle-market companies, the process can involve assessing debt capacity, preparing lender materials, evaluating security arrangements, and coordinating a financing review.

However, an adviser cannot guarantee a lender's approval, pricing, or commitment.

Rainstar Capital Group acts as a debt adviser and intermediary through its lender relationships. Its advisory role should not be confused with the direct lending or investment activities of its separately identified sister companies.

Discuss Middle-Market Financing With Rainstar Capital Group

An effective capital structure should support operating liquidity, manageable repayment obligations, and the company's longer-term financial priorities.

Rainstar Capital Group helps commercial borrowers explore debt financing opportunities through its lending relationships, including corporate finance and asset-based arrangements.

A financing discussion may begin with the company's current debt schedule, financial results, borrowing requirements, collateral, and anticipated transaction timeline.

Final terms and funding remain subject to the participating lender's underwriting and closing conditions.

For a broader explanation of Rainstar's advisory process, review the main Middle-Market Debt Advisory page once published.

Start a Financing Discussion With Rainstar Capital Group

Frequently Asked Questions About Middle-Market Capital Structure