Resilience Redefined: How Quality of Earnings Unlocks Capital in a Tightening Market

Resilience Redefined: How Quality of Earnings Unlocks Capital in a Tightening Market

A shocking 6.2% (up from 4.7%) of lower middle market (LMM) borrowers are currently on "default radar," a significant increase compared to broader lending. This stark reality underscores a critical truth for LMM manufacturing leaders: strong effort and solid execution alone no longer guarantee access to capital. The lending landscape has fundamentally shifted, and your creditworthiness demands a deeper, more credible signal than ever before.

The traditional debt markets are no longer the reliable partners they once were. Banks are pulling back, private credit is demanding higher rates and more stringent terms, and the broader economy is uncertain at best. In this situation, your finances aren't enough to show that you're flexible, clear about how your business works, and have options for your strategy.

The critical signal? The quality of your earnings (QoE).

What’s Really Changed in the Lending Landscape for LMM Manufacturers?

If you’re a manufacturer in the LMM (typically $10M–$100M in revenue), you’re feeling the unprecedented squeeze. Let’s break down the latest trends:

1. Stricter Underwriting, Deeper Scrutiny: Lenders are looking deeper than just historical financials. What was once a relationship-driven process is now a forensic examination. Expect longer due diligence, intrusive audits, and far tighter loan covenants, particularly maintenance covenants that demand stricter financial performance. This isn't about proving you're profitable; it's about proving you're stable.
2. The Rise (and Inherent Risk) of Private Credit: As traditional banks pull back, private credit funds are aggressively stepping in. While they offer speed and flexibility, this comes at a price: higher interest rates, more complex structures, and often, more aggressive terms. Jamie Dimon’s public cautions about this growing, less transparent market (even as JPMorgan enters it with force) underscore the systemic risks baked into this apparent "optionality." This market, potentially hitting $3 trillion by 2028, also comes with a downside.
3. Default Pressure is Mounting Beneath the Surface: While official default rates may seem low (1.3% for LMM as of April 2025), the underlying data tells a more sobering story. Non-accrual rates (missed payments) are double that of larger borrowers at 3.2%. A concerning 6.2% of LMM borrowers, up from 4.7%, are on "default radar." The increasing use of Payment-in-Kind (PIK) financing further signals a widespread cash stress. Lenders are seeing this and they understand that many are skating on thin ice.
4. Interest Rates & Valuation Compression: If you hold floating-rate debt, you’re already feel the painful reality of increased servicing costs. For those seeking to refinance, prepare for substantially higher rates. This directly impacts valuations, especially for leveraged buyouts. Strategic buyers with strong balance sheets now hold the upper hand, leading to slower deal volume and a more cautious private equity landscape.

The Case for Quality of Earnings: Your Strategic Leverage in 2025 and Beyond

In an environment demanding resiliency, clarity, and optionality, a Quality of Earnings (QoE) assessment transcends a mere accounting exercise. It’s a deep dive into the accuracy, sustainability, and transparency of your earnings, revealing whether they genuinely reflect your cash flow. This analysis is now a vital tool across borrowing and credit markets, particularly impacting:

1. Creditworthiness Assessment: Lenders utilize QoE reports to gain a profound understanding of your company's ability to generate consistent and sustainable cash flow to service debt. High-quality earnings, those rooted in core operations and backed by robust cash flow, signal superior financial stability and significantly reduce perceived credit risk. Conversely, low-quality earnings—resulting from one-time events, aggressive accounting, or unsustainable revenue streams—raise critical red flags about your financial health and capacity to meet obligations.
2. Debt Capacity and Loan Terms: The quality of your earnings directly dictates the terms you can secure. Higher Quality of Earnings: Firms with more predictable and high-quality earnings command more favorable loan terms, including lower interest rates, longer maturities, and fewer restrictive covenants or collateral requirements. This demonstrates undeniable financial strength and predictability. Lower Quality of Earnings: Companies with less predictable or lower quality earnings face higher interest rates, shorter loan maturities, and more stringent covenants and collateral demands. Lenders require a risk premium and tighter controls to mitigate the increased perceived default risk.
3. Investor Confidence and Valuation: QoE reports offer investors a more transparent view of your company's financial health, empowering more informed investment decisions. High-quality earnings enhance investor confidence, potentially leading to higher valuations and greater investment appeal. Conversely, low-quality earnings deter investors, creating uncertainty and potentially depressing your company's valuation.
4. Mergers and Acquisitions (M&A): QoE reports are absolutely crucial for both buyers and sellers in M&A transactions. Buyers leverage QoE to validate the seller's stated earnings and rigorously assess their sustainability for valuation and financing. Sellers, on the other hand, can proactively utilize QoE reports to identify and rectify potential issues that could impede a sale or lead to lower valuations during due diligence.

Simply put, a professional QoE assessment provides critical optionality and strategic leverage in a market that has become unforgiving. It helps lenders, investors, and other stakeholders make well-informed decisions by providing a comprehensive and reliable picture of your company's financial health and future earnings potential.

Higher Quality of Earnings: a Bulletproof Business Model

Improving your QoE isn't just about preparing for a transaction; it's a strategic move to build a more valuable, resilient business. Here's where to focus:

1. Cultivate Self-Sustaining Revenue Streams: Go beyond superficial revenue figures to analyze the underlying drivers of your income. Is your revenue reliably recurring, or is it predominantly transactional? Is it overweighted on a single industry or customer? Evaluate the strength of your contractual commitments and the breadth of your customer base. The strategic aim is to build a revenue model that inherently generates consistent, compounding value and propels your business forward.
2. Increase Stability of Earnings: Balance profits from recurring revenues to operational overhead. Increasing services, aftermarket parts, consumables, and recurring contracts increases the stability of earnings year over year. Services also have the benefit of higher margins. Balancing overhead spend to your recurring profits all but eliminates the need for reactive restructuring. So while your competitors are reacting, you have more and better options.
3. Create and demonstrate the ability to execute on optionality: Have gas in the tank and discipline to know when to use it. Even more valuable that a one-time spike in revenue is a backlog of great ideas coupled with a track record of turning good ideas into profitable growth.
4. Demonstrate Pricing Power: Understand the relative value your business brings to the ecosystem and show how you use that capture price. Ideally you can show that you have higher margins than peers and that you have a track record of price increases above inflation. Note that high price does not mean high cost; quite the opposite. That’s where your higher margins are developed.
5. Organization-wide focus on customers: Everyone is working together to deliver to commitments. Late deliveries and quality issues are indications of an organization that is struggling to keep up with the volume you have now. By doubling your growth rate do you break the operations?

Not Selling or Borrowing? Here's Why QoE Still Matters

You might be thinking, "I'm not looking to sell my business or take on new debt right now, so why should I invest in a QoE assessment?" The answer is simple and profoundly strategic: high-quality earnings are inherently more profitable.

A professional QoE report isn't just about external validation; it's an invaluable internal diagnostic tool. It can pinpoint specific weaknesses within your business model—areas where profits are leaking, efficiencies are lacking, or revenue streams are less sustainable than they appear. By identifying and addressing these vulnerabilities, you can proactively strengthen your operations, optimize your cost structure, and unlock significant opportunities to increase your current profitability and cash flow. It's about building a fundamentally stronger, more resilient enterprise, regardless of your immediate capital needs.

The Bottom Line: Lenders Demand Signals, Not Just Statements

In today’s volatile environment, lenders are looking past the P&L and balance sheet. They are searching for undeniable signals of discipline, strategic foresight, and long-term viability.

A professional-grade QoE review, whether done in-house with expert help or through an advisor, is probably the best investment you can make in a market that is getting tighter. You want to be the borrower who gets the lender to say YES when rates go up and access to capital becomes harder to get.

What BluGrowth Partners Can Do For You

At BluGrowth Partners, we understand that building a resilient, high-performance business model requires not just effort, but a Bulletproof Business Model. If you’re a manufacturing leader in the LMM feeling the pinch of higher capital costs, it's time to elevate your strategy from "just keep the numbers strong" to "prove we’re built to last."

Whether you’re preparing for debt, M&A, or simply aiming for more resilient operations, enhancing your quality of earnings is the smartest path to:

• Differentiate yourself in an increasingly crowded and skeptical lender market.
• Gain critical leverage in negotiations, securing terms that protect your future.
• Build enduring long-term enterprise value that withstands market shocks.

We help leaders create more paths to growth—and the clarity to choose them. This isn't just about financial hygiene; it's about strategic optionality.

What else we are reading this week

Jamie Dimon Says Private Credit Is Dangerous—and He Wants JPMorgan to Get In on It Bank puts $50 billion toward lending to riskier companies to compete with nonbank giants. His plan: swoop in strategically and profit if there’s a meltdown.

Credit Market Themes in 5 Charts Q2 2025 extended the trend of heightened volatility across asset classes, and these five charts highlight what we see as some of the key themes and opportunities in the current market environment.

The Fram Dispatch

This "Dispatch" aims to equip you with the strategic clarity and confidence needed to build business models engineered for resilience and growth. Just as the Fram was designed to overcome relentless pressures, BluGrowth Partners helps B2B firms leverage our comprehensive GROWTH Framework—encompassing Generative Flywheel, Relative Value, Optionality, Waterline, Triple Bottom Line, and Harmonized Growth—to navigate complex markets, unlock new opportunities, and ensure sustainable, future-proof performance.

Learn more about how BluGrowth Partners can help your business thrive at BluGrowth.com.