Rethinking debt financing approaches for Canadian productivity

Economic uncertainty, technological disruption, and relentless competition are pushing mid-market enterprises to rethink not only how they operate, but how they invest for the future. The ability to boost productivity is now a defining factor between industry leaders and those left behind.

Yet, many organizations may be limited by conventional financing approaches, missing out on opportunities to invest in automation, expansion, or strategic acquisitions that could propel their business further. What if the key to unlocking your organization’s next wave of growth isn’t just about working harder, but about accessing alternative capital pools and financing smarter?

Debt capital, especially through alternative structures like subordinated loans, stretch senior loans, and unitranche loans can reshape what’s possible for Canadian businesses. These alternative options can bridge funding gaps and empower organizations to pursue growth on their own terms, unlocking new levels of efficiency, total cost of capital savings, and strategic agility. By rethinking your approach to debt capital, your company can transform debt into a powerful driver of productivity and long-term success.

Organic and inorganic growth can drive productivity enhancements for mid-market private enterprises. However, companies face a perennial challenge: how to finance sustainable growth without diluting ownership, over-leveraging, or straining cash flows.

Unlike their sponsor-backed counterparts, which benefit from private equity muscle and established lender relationships, independent businesses often operate in a financing ecosystem marked by more traditional approaches to senior debt only solutions.

Traditional senior debt only solutions, either cash flow- or asset-based, have long been the go-to option for private enterprises. Typically provided by relationship banks, it can offer competitive loan spreads and a simpler capital structure.

Yet, it has limitations: more conservative leverage ratios (higher equity investment in growth transactions), more restrictive covenants, and shorter amortization periods. The choice of debt structure, including alternative structures, can enable mid-market enterprises to invest in productivity-enhancing initiatives without compromising broader shareholder and business objectives.

Alternative debt structures challenge this traditional approach by offering more accommodative terms tailored to the realities of mid-market growth that can fuel productivity.

Subordinated debt: Also referred to as ‘junior capital’ is debt that ranks junior to senior debt. Subordinated debt can be paired with senior debt solutions as separate loan facilities to achieve financing objectives. Subordinated debt is priced higher than senior debt, is usually unsecured, and may include limited covenants, and payment-in-kind features. Often overlooked as ‘too expensive’ in relation to senior debt, subordinated debt remains lower cost compared to equity.

Stretch senior loans: Also referred to as ‘senior stretch’ financing, represent a hybrid approach that extends beyond standard senior debt limits. Essentially, these loans ‘stretch’ the senior tranche to incorporate elements of junior debt, providing higher leverage without the need for separate subordinated debt facilities. This structure is particularly advantageous for private companies lacking sponsor backing, as it simplifies the capital stack into a single layer, reducing intercreditor complexities and legal fees. With this enhanced borrowing capacity, businesses can fund larger capex projects to achieve organic growth objectives without tapping additional equity sources. 

Unitranche loans: Taking innovation a step further, unitranche loans merge senior and subordinated debt into a unified facility with a single interest rate and set of covenants. Originating in the private credit space, unitranche financing is gaining traction in the Canadian upper mid-market, where direct lenders or alternative funds fill voids left by traditional banks. Unlike traditional senior debt, which prioritizes low-risk profiles, unitranche offers higher leverage, with blended rates that average out the costs of separate tranches. This could enable quicker execution and eliminate multi-lender complexity. 

An example of this is when a mid-market Canadian company identified a transformative acquisition opportunity, but their relationship bank only offered traditional senior debt, requiring a large equity injection. With KPMG Canada’s help, they pursued alternative financing, exploring a senior and subordinated debt solution, stretch senior solutions, and unitranche options, and ultimately secured a financing solution that enabled the acquisition with less equity, faster execution, and more flexible terms—accelerating productivity and growth.

As your organization seeks debt capital for new growth opportunities, consider asking:

• What are the limitations of traditional senior debt only when it comes to funding productivity-enhancing growth?
• How could alternative debt structures address these gaps?
• How could the increased borrowing capacity of alternative debt structures directly support productivity initiatives such as automation, expansion, or modernization?
• How does the flexibility and speed of alternative debt structures help respond to productivity in a dynamic market environment?
• How could optimized debt structures in the capital stack amplify returns on invested capital, enabling bolt-on acquisitions that might otherwise be out of reach?
• How could alternative debt structures provide faster access to capital, more flexible repayment terms, or the ability to finance productivity-enhancing investments?

Mid-market Canadian leaders can take the following actions to boost growth and productivity through alternative debt structures:

• Identify organic growth opportunities: If you’re making investments in your business, identify how capital expenditures in equipment, technology, and facilities could improve productivity. 
• Identify inorganic growth opportunities: If you’re acquiring another business, identify how the target’s business could create synergies and drive productivity enhancements.
• Understand your financing challenges: Explore the impacts of traditional financing on your growth objectives, and investment thesis.
• Consider your options: Assess all funding and capital structure options beyond traditional senior debt only solutions to understand alternatives which require less equity, optimize cost of capital, and align with growth and productivity objectives.
• Assess alternative debt structures: Assess how alternative debt structures like subordinated loans, stretch senior loans, and unitranche loans could help you achieve growth outcomes linked to productivity improvements.
• Look for credit enhancement and de-risking opportunities: In the current environment, Export Development Canada (EDC) products and programs are evolving which can support Canadian private enterprise with achieving growth objectives. These programs provide a guarantee to the lending bank sharing the risk and allowing the business to secure a larger loan than might otherwise be available. 

Traditional senior debt only serves a purpose for private enterprises, but for transformative growth via capex or acquisitions to drive productivity enhancements, subordinated loans, stretch senior and unitranche loans may offer a compelling path forward. They provide not just capital, but the opportunity for strategic freedom, minimizing dilution, optimizing cost of capital, and alignment with owner visions. Alternative debt structures are not just financial tools, but enablers of productivity and competitive advantage for Canadian businesses.