Birch Lake Insights: Middle Market Valuation Squeeze and the Turn Toward Structured Capital

By Kyle Stewart

The M&A landscape has changed dramatically in recent years as covenant-light loans originated during the era of ultra-low-cost capital begin to mature, expected rate relief fails to materialize, and AI reshapes the global economy. Despite these pressures, megadeals-transactions with enterprise values above $5B-are on pace to trade roughly 40% higher year over year, according to a PwC study. At the lower end of the market, activity has also accelerated, with Capstone Partners reporting an almost 46% increase in sub-$100M deal volume in the first quarter. Between those extremes, however, the middle market remains far quieter. The core middle market-roughly $100M to $250M in enterprise value-sits in a difficult middle ground: too large for the growing pool of new independent sponsors or easy balance-sheet bolt-on financing, yet too small to attract meaningful attention from upper-market investors.

The result is a barbell-shaped M&A market. Capital is confidently deployed at the top and the bottom, while the middle waits. For an owner in that space, the consequence is less competition in the process, and less tension on price. Transactions above the $250M mark average ~12.2x EV/EBITDA in Q1. Owners of businesses in the tier below anchor to those valuations, while the buyers do not.

The real problem is transaction form, not volume.

Most commentary on this phenomenon treats this as a story about deal count - "activity is down, and will return when conditions improve." This framing of the issue mischaracterizes the reality of the situation.

Liquidity needs in the middle market have only intensified. Founders are still aging, succession timelines still matter, debt issued in the 2021 rate environment is still maturing, and management teams still need capital to pursue visible growth that traditional financing may not support. These pressures are not discretionary, and they are unlikely to pause simply because middle market valuations remain below owners' expectations.

When valuations don't meet expectations, it doesn't change the need to execute a transaction, it changes the shape a transaction takes. Capital is placed in the middle of the balance sheet - the "real estate" between senior debt and common equity - because that is where a deal can be built when there is disagreement on valuation, but agreement that something needs to be done.

The current environment is primed to produce more structured capital, not less activity. Sponsors under pressure to return capital and founders unwilling to sell at today's prices arrive at the same place from different directions.

The problems owners face, and how structure solves them

Owners understand the problem clearly, but aren't aware of the right solution.

"I want to pull cash out of the business, but don't want to give my company away."

One of the most common conversations we have is with a founder or investor group who seek to take some chips off the table, without giving up their company. In this instance, a control sale is not the solution. A structured minority investment or a preferred equity position can deliver meaningful liquidity to stakeholders - often a life-changing amount - while leaving day-to-day decision making where it is. Business owners diversify their net worth away from a single illiquid asset, take real money off the table, and keep the upside on the equity they retain. Critically, the transaction does not require agreement on the value of the business today - it requires them to agree on the terms of one piece of it.

"I have debt maturing and my lender won't extend terms I can live with."

A maturity that arrives in a soft market is not automatically a distressed situation, but it becomes one if it is not addressed in a timely manner. Junior capital layered beneath existing senior debt, or a recapitalization that resets the whole structure, can retire the pressing maturity, restore covenant leeway, and buy extended runway to transact from a position of strength rather than urgency. Owners who address this a year or more before loan maturity can negotiate. Companies who wait to address in the months leading up to maturity accept what is offered where there is no time or leverage to pursue alternatives.

"We are primed for growth, but I don't want to fund it by issuing equity at this valuation."

Selling common equity when growth prospects are promising but the market is not, means selling your most valuable asset at the worst time. For businesses with identifiable, durable revenue streams, royalty or revenue-based financings can monetize a piece of the cash flow without a sale of the enterprise and without dilution. Structured growth capital can fund an acquisition or an expansion while preserving an owner's equity position for a stronger market.

Each of these structures costs something - a coupon, a preference, a share of future revenue. When priced strategically, that cost is well below the cost of selling the business at a discount, and even further below the cost of doing nothing.

Advanced strategic preparation is the primary variable that owners can control

The companies that have viable options are those who plan and are agile enough to move quickly when an opportunity or obligation arrives. It means business and financial planning is done before it is demanded, reporting structures are built to withstand rigorous diligence and an internal view of business value is established with supporting rationale, and is tested against the market. The current valuation gap in the core middle market is real, and it may persist. Companies that prepare for a market that requires structure, rather than waiting for one that doesn't, will find they have more options than the publicized deal count suggests.

At Birch Lake, Kyle Stewart sources, evaluates and executes investment opportunities while partnering with management teams on capital strategy and operational improvements. He joined Birch Lake from a private equity consulting and principal investing firm, where he helped launch the financial due diligence and CFO services practice and supported investment evaluation, capital raising and transaction execution.