Flexible Capital as a Strategic Tool for the Middle Market
Key takeaways
- Core middle market companies, with $25-75M of EBITDA, increasingly need financing beyond senior debt. Yet private credit growth has concentrated in senior direct lending, leaving the flexible capital that can meet those needs less crowded.
- Longer private equity hold periods, higher-for-longer rates, and a looming maturity wall are straining sponsors and their portfolio companies. Flexible capital can fund growth and refinancing without dilution or loss of control.
- Seniority is not the only source of downside protection. Flexible capital spans from subordinated debt to common equity and, used selectively, can pair disciplined downside management with upside potential.
Executive summary
A mix of structural and cyclical forces is reshaping financing needs in the middle market. In this paper, we will explore the factors changing middle market borrowers’ access to capital, the opportunity flexible capital presents, and Bain Capital Credit’s distinctive investment approach.
While senior secured debt has delivered compelling returns over recent years, benefiting from elevated base rates and strong downside protection, the current market environment rewards flexibility. Sponsors increasingly seek capital solutions that extend beyond traditional lending structures, creating opportunities for capital providers with a broader toolkit. Flexible capital enables investors to calibrate risk and return, support complex situations, and deliver bespoke financing solutions that address sponsor needs while generating attractive risk-adjusted returns.
The middle market opportunity
The middle market offers private credit investors attractive market segment attributes, including strong borrower quality, consistent deal flow, and favorable competitive dynamics. Borrowers typically have experienced management, established systems, and disciplined, levered balance sheets, supporting durability and adaptability. The segment is larger than the $100M+ EBITDA cohort, where fundraising has concentrated despite limited supply, and benefits from a steady pipeline of companies scaling up from the lower middle market. Deal activity is less reliant on change-of-control transactions and remains attractive to sponsors. Borrowers’ preference for long-term partners with structuring expertise keeps barriers to entry high. Scaled providers thus see healthy deal volume and less competition versus other market segments, enabling better pricing, stronger structures, and greater investment selection.
Forces reshaping sponsor financing needs
1. Extended private equity hold periods drive flexible capital demand
Private equity continues to build on decades of sustained expansion. We believe dry powder raised across the industry will continue to create demand for new debt. In addition to the growth in dry powder, unrealized value has surged in recent years as private equity firms have held onto their portfolio companies for longer. According to data from Hamilton Lane, 65% of buyout deals have been held for five years or longer.
This trend is fueled by a combination of elevated interest rates and a shifting macroeconomic environment, causing a widening gap between would-be buyers and sellers. The lack of transaction activity has slowed down realizations and distributions in the private equity industry, adding pressure to sponsors to return capital to their investors. We believe this trend will further drive demand for realizations and additional growth initiatives to middle market sponsors.
2. Higher-for-longer interest rates reduce capacity for floating rate senior debt
Despite interest rate cuts in 2025, base rates remain elevated relative to prior vintages, driven by higher inflation levels. As a result, traditional floating-rate senior debt can be less sufficient in maximizing company financing needs for middle market companies. Flexible capital provides an opportunity to reduce a company’s cash interest burden while simultaneously unlocking greater capacity to fund growth initiatives and finance new buyouts.
3. Looming maturity wall across the middle market
Private debt maturities will reach near-term peak volumes in 2028 and 2029. With sponsors addressing these maturities one to two years in advance, we expect sponsor activity to increase. Furthermore, with elevated base rates and many portfolio companies carrying legacy capital structures, refinancing will be more challenging, creating additional demand for flexible capital solutions.
Thinking differently
When conditions become more complex, investors often emphasize seniority as a proxy for downside protection. However, positioning alone does not always determine risk—or return. Rapid growth in private credit has been heavily concentrated on senior direct lending, particularly within the large cap and upper middle-market market segment, driving increased competition and downward pressure on pricing and lender protections.
Flexible capital provides valuable and differentiated financing solutions across the capital structure. It includes a wider set of securities beyond senior secured, including subordinated debt, preferred equity, or common equity that offer enhanced return potential while being able to maintain a strong emphasis on downside management. Many borrowers access this market, including traditional private equity sponsors, independent sponsors, and family- or management-owned businesses. Borrowers generally value flexible capital for structured support to pursue growth, acquisitions, recapitalizations, or other strategic initiatives. Today, flexible capital has become a critical component of the middle market financing landscape, enabling company owners and management to navigate complexity without resorting to dilutive equity, or control-oriented capital.
Looking across private credit debt strategies, we believe there is significantly less competition, both in terms of funds raised and the number of providers financing flexible capital solutions through “Mezzanine” strategies as compared to Senior Direct Lending. This creates an opportunity to secure attractive lender terms and to act as a price maker rather than a price taker given less supply in the market, lessening competition.
Flexible capital/mezzanine funds have historically provided investors attractive returns across various rate environments supported by higher fixed rate debt exposures. While senior direct lending returns have been elevated in recent years, the gap has begun to shift back in favor of flexible capital strategies.
How flexible capital works
Flexible capital is typically provided in response to performing middle market borrower needs through two forms: buyout support and capital solutions:
Buyout support
Buyout support finances leveraged buyouts for both traditional and non-traditional sponsors: fund-less sponsors, search funds, and family- or management-owned businesses. Sourcing typically runs through a sponsor coverage network or sponsor coverage networks and the broader platform relationships. Structures typically involve subordinated debt and preferred equity for traditional sponsors; senior secured debt alongside common equity co-investments for non-traditional sponsors.
Capital solutions
Capital solutions address more complex financing needs for performing borrowers: tuck-in acquisitions, growth capex, senior deleveraging, dividend recapitalizations, and shareholder buyouts. Sourcing typically draws on the same sponsor network, supplemented by senior lenders and banks for situations requiring creative solutions. Structures are deliberately flexible: subordinated debt, preferred equity, common equity, warrants, or HoldCo structures, calibrated to the borrower’s actual needs.
The composition of flexible capital needed for middle market borrowers has evolved alongside changing macroeconomic and market conditions. In the 2010–2017 period, activity was relatively balanced between buyout support and capital solutions, reflecting a healthy M&A environment and robust economic growth. As the post-GFC expansion began to moderate during 2018–2021, growth expectations became less bullish and market volatility increased, culminating in the disruption caused by COVID-19. More recently, higher interest rates, lower sponsor M&A activity, and a widening gap between buyer and seller expectations have driven a meaningful shift toward capital solutions opportunities, which has driven the majority of our investment activity in recent years.
Across both buyout support and capital solutions needs, our investments focus on downside management with upside potential. Senior secured and second-lien investments emphasize capital preservation through strong covenant packages, priority in the capital structure, and lender control, making them well-suited for stable, cash-flowing businesses. Subordinated debt investments sit higher in the capital structure relative to equity, relying on enterprise value support and often incorporating PIK features while still maintaining debt-like protections. Preferred and common equity investments provide greater flexibility and potential upside participation, often alongside governance rights that align investors with sponsors and management teams. Typical features of each security type are summarized below:
Senior secured (first lien) |
Subordinated debt |
Preferred equity |
Common equity |
||
|---|---|---|---|---|---|
Second lien |
Mezz Holdco notes |
||||
Borrower characteristics |
|
|
|
||
Control of tranche |
Often a majority or sole lender |
Often a majority or sole lender |
Often a majority or sole lender |
|
|
Coupon |
Floating; mostly cash pay |
Floating/Fixed; cash and/or PIK |
Fixed; mostly PIK |
Fixed; mostly PIK |
N/A; return driven by equity upside potential |
Typical spread/return |
600-800bps |
800-1,100bps |
12-15% |
14-17% |
20-25% |
Debt incurrence protections |
✓ |
✓ |
✓ |
✓ |
|
Restricted Payment Protections |
✓ |
✓ |
✓ |
✓ |
|
Financial covenants |
✓ |
✓ |
✗ |
✗ |
|
Exit Rights |
Contractual Maturity |
Contractual Maturity |
Contractual Maturity Economic Incentives for Redemption |
||
Prospective investors should also bear in mind that past or typical investment characteristics or portfolio construction may not be indicative of future investment characteristics or portfolio construction. Prospective investors should not place undue reliance on any such hypothetical information. Typical spreads and returns are presented on a gross basis before the deduction of fees and expenses and are based on past investment performance and future expectations of market conditions. Typical results may not be achieved. Typical performance is hypothetical in nature and has inherent risks and limitations. Actual results may vary. For illustrative purposes only.
Case study: Flexible capital in action
Owned by an experienced private equity sponsor, the company had successfully expanded through acquisitions and more than 60 new store openings, generating over $50 million of EBITDA. While operating performance remained strong, growth had been financed primarily with senior debt. Rising base rates significantly increased cash interest expense, leaving limited free cash flow to fund additional expansion or acquisitions despite substantial underlying enterprise value.
Traditional financing options were insufficient, as incremental senior debt would have further increased the company’s cash burden and equity capital would have been dilutive. Instead, we structured a $75 million HoldCo PIK investment designed to improve the company’s financial flexibility. Approximately $50 million was used to reduce senior debt, enabling lower borrowing costs and the reinstatement of a new acquisition facility. The remaining capital funded continued greenfield expansion without increasing cash interest obligations.
Investment Profile
growth
- No free cash flow to support incremental debt
- No M&A capacity
Investment Profile
EBITDA growth
- De-levered first lien to improve cash and added junior debt
- Created new M&A capacity to further growth
In closing
As the middle market continues to evolve, we believe investors will need to look beyond traditional assumptions about risk and capital structure positioning. Flexible capital offers a differentiated approach, one that can adapt to complexity, align with sponsor needs, and pursue attractive risk-adjusted returns. Across market cycles, flexibility is a competitive advantage and, in this specific instance, serves as a strategic tool for managing risk and expanding opportunities.
When capital structure, not business fundamentals, is the constraint, flexible capital can align sponsors, lenders, and management teams to unlock growth and create value.
Endnotes
Definitions
- “Default Rate” is calculated as $ Defaulted Par divided by $ Invested. Total represents Cumulative Default Rate since inception.
- “Loss Rate” is the default rate multiplied by difference between: (1) Par and (2) Recovery Rate for each outlined period, and measures total impact of default losses on investment population, net of recoveries.
- “Loss Adjustment” represents the dollar amount of defaulted assets applied to the cash flows to generate the total impact to IRR of default losses on the investment population, net of recoveries. “Dollar amount of defaulted assets” is equal to (Defaulted Par Amount) (1 – Recovery Rate).
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