The Small Middle Market Financing Checklist & Execution Playbook
Introduction
Articles 1 through 3 covered the why and the how-to of assessing debt capacity:
the fundamentals of LBO mechanics, how collateral defines the upper boundary of leverage,
and how the Cash Conversion Cycle converts operations into debt service.
This final instructional piece is the execution playbook for combining those insights
into a clear, lender-ready financing model. It walks through calculating the Total Capital Need,
structuring the Sources of Funds, validating the Required Debt against the capacity tests
from prior articles, and aligning the final structure with the practical realities of closing
the transaction.
Key Points
- Total Capital Need (Uses) must include purchase economics, refinancing, fees, and liquidity to avoid undercapitalization.
- Sources of Funds are structured around buyer equity, seller financing, and Required Debt.
- Required Debt must pass the Collateral Test and Repayment Test established in prior articles.
- A well-designed capital structure balances borrowing power with liquidity protection and execution certainty.
- The final purchase structure (stock vs. asset) must support both tax outcomes and lender requirements.
Definitions
Total Capital Need (Uses): The complete set of costs required to acquire and stabilize the business.
Sources of Funds: The capital components used to meet the Total Uses (equity, seller note, debt).
Required Debt: The portion of the capital stack not funded by equity or the seller note.
Collateral Test: A measurement of how much senior secured debt the asset base can support (Part 2).
Repayment Test: A measure of the business’s ability to service debt using EBITDA and CCC (Part 3).
1. Calculating Total Capital Need (Uses of Funds)
The first responsibility of the buyer is to compute the maximum capital required to close the transaction
and operate the business immediately after. Underestimating Uses is the most common mistake in first-time acquisitions.
Table 1 — Common Uses of Funds
| Use Category | Description |
|---|---|
| Purchase Price | Final negotiated value for stock or assets. |
| Existing Debt Refinancing | Payoff of all target company debt at closing. |
| Transaction Costs | Typically 3%–5% of purchase price: legal, accounting, QoE, and advisory. |
| Financing Fees | Generally 1%–3% of new debt issued. |
| Working Capital Injection | Cash provided at close to support liquidity; especially important when CCC performance is weak or operational changes are planned. |
Formula:
Total Capital Need = Sum of All Uses
A proper Total Capital Need eliminates the risk of post-close liquidity strain and
shows senior lenders a responsible, fully funded structure.
2. Structuring the Funding (Sources of Funds)
Once Total Uses are known, the buyer assembles the Sources of Funds. The goal is to balance equity,
seller financing, and Required Debt in a way that meets lender expectations and supports execution.
Table 2 — Sources of Funds Overview
| Source Category | Role in the Capital Stack |
|---|---|
| Buyer Equity | Primary risk capital; demonstrates commitment. |
| Seller Note | Subordinated financing bridging valuation and lender appetite. |
| Required Debt | Senior or unitranche debt needed to complete the transaction. |
Relationship Between Uses and Sources
- Total Sources must equal Total Uses.
- Any shortfall becomes Required Debt.
3. Execution: Confirm Required Debt Against Capacity Tests
Before engaging lenders, the buyer validates that the Required Debt is feasible.
This relies on the Collateral Test (Part 2) and the Repayment Test (Part 3).
Table 3 — Debt Capacity Tests
| Test | Derived From | Purpose | Outcome |
|---|---|---|---|
| Collateral Test | Part 2 — ABL borrowing base and appraisals | Determines maximum senior secured debt | Establishes upper lending bound |
| Repayment Test | Part 3 — EBITDA, CCC, DSCR | Determines leverage supported by cash flow | Confirms sustainable total debt multiple |
Lender Placement Strategy
| Debt Provider | Best For | Characteristics |
|---|---|---|
| Traditional Bank | 3.0x–3.5x leverage | Lower cost, more covenants, stricter collateral reliance |
| Unitranche / Private Credit | 4.0x–5.0x leverage or complex cases | Flexible terms, faster execution, holistic underwriting |
Matching Required Debt to the right provider improves closing certainty and reduces pricing tension.
4. Final Structural Decision: Stock vs. Asset Purchase
The final structural decision influences tax treatment, collateral quality, timing, and lender comfort.
Asset Purchase
- Pros: Tax basis step-up, clean collateral, fewer legacy liabilities.
- Cons: Requires contract assignments, potential retitling effort.
Stock Purchase
- Pros: Simpler, retains contracts, faster close.
- Cons: Carries legacy risks; lenders may require expanded diligence.
Whichever structure you choose has to align with the financing plan and lender requirements.
Download the Capital Source LBO Financing Checklist here.
Conclusion
This final piece completes the four-part series on small and middle market financing. By calculating
Total Capital Need, assembling the Sources, validating Required Debt through the Collateral and
Repayment Tests, and aligning the final structure with lender expectations, buyers can create
a financing plan that withstands scrutiny and supports a successful close.
FAQ
1. How much equity should a buyer typically contribute?
It varies by deal size, but small to middle market lenders generally expect buyers to contribute
at least 10%–20% equity.
2. When should a seller note be introduced in negotiations?
Introduce it once valuation expectations and lender appetite diverge. It is often the most efficient bridge.
3. What happens if the Required Debt fails the capacity tests?
The buyer must adjust: increase equity, renegotiate the seller note, reduce purchase price,
or revise the Uses.
4. Is a working capital injection always required?
Not always, but lenders prefer a buffer unless CCC performance is consistently strong.
5. How early should lenders be engaged?
Only after the model is fully built and the Required Debt has passed both capacity tests.
If you would like help validating your Total Capital Need or structuring a complete Sources & Uses model,
Capital Source provides confidential, practical guidance for buyers and operators. Our team supports the full
process—from diligence through closing—to keep your structure financeable and execution-ready.
If you are evaluating capital needs for 2026—whether for growth, recapitalization, or acquisition—consider sharing your scenario with Capital Source to determine if a tailored private credit solution is appropriate for your business.
📞 Contact us today to explore options customized to your business needs.
Ready to Move Forward?
Proud to be ranked on the 2024 and 2025 Inc. 5000 list of America’s fastest-growing private companies