Capital Southwest Forms 50-50 Joint Venture to Boost Lower Middle-Market Lending

Capital Southwest Corporation has created a new joint venture designed to expand its footprint in the lower middle-market private credit space. The Dallas-based business development company disclosed on January 22 that it will share ownership of the off-balance-sheet vehicle equally with an unnamed private credit asset manager.

The venture will concentrate on first-out senior secured debt, a position in a company’s capital structure that receives priority in repayment. By focusing on this segment, both partners aim to address financing needs of lower middle-market platform companies—businesses that typically generate annual earnings before interest, taxes, depreciation and amortization (EBITDA) of roughly $10 million to $50 million. According to industry data compiled by the U.S. Securities and Exchange Commission, business development companies often target this market segment to capture attractive risk-adjusted yields while supporting smaller enterprises that may lack access to traditional bank financing.

Structure and Governance

Capital Southwest and its partner will each hold a 50 percent equity stake in the newly formed entity. Governance will be overseen by a board of managers comprising equal representation from both firms. This structure is intended to ensure balanced decision-making on investment selection, portfolio monitoring and operational matters.

Management indicated that the joint venture expects to secure a senior secured credit facility. Borrowed funds from that facility will be combined with equity capital to support the purchase of loan assets, a strategy designed to increase deployment capacity while maintaining an acceptable level of leverage. Specific terms of the credit facility, including committed amounts, pricing and maturity, were not disclosed.

Strategic Rationale

Leadership at Capital Southwest said the initiative should enhance the firm’s competitiveness by offering more flexible capital solutions to borrowers and sponsors. The company noted that the off-balance-sheet format makes it easier to syndicate portions of larger transactions into the joint venture, helping Capital Southwest preserve diversification within its primary portfolio while still underwriting larger deals.

Chief Executive Officer Michael Sarner stated that the new platform broadens the range of opportunities the company can pursue and allows Capital Southwest to compete for mandates it might not have otherwise considered on a standalone basis. Management also sees potential efficiency gains, as the venture can concentrate on first-out tranches while Capital Southwest retains positions in other parts of the capital structure when appropriate.

Background on Capital Southwest

Capital Southwest Corporation is an internally managed, publicly traded business development company listed on the Nasdaq under the ticker CSWC. As of September 30, 2025, the firm reported approximately $1.9 billion in investments at fair value, spanning senior secured loans, mezzanine debt and equity co-investments. The company primarily targets lower middle-market businesses located in the United States.

Capital Southwest pays a monthly dividend, a feature that has placed the stock on various income-oriented lists, including a recent ranking of the 10 best monthly dividend stocks. Management has historically emphasized a consistent distribution policy supported by recurring interest income from its loan portfolio.

Market Context

The lower middle-market lending environment has been influenced by several factors in recent years. Demand for flexible credit solutions has grown as traditional banks have retrenched from smaller corporate borrowers due to regulatory capital requirements. Simultaneously, private equity sponsors continue to raise funds focused on platform roll-ups, further increasing the need for debt financing alternatives.

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First-out senior secured structures offer lenders priority in the repayment waterfall, which can mitigate credit risk while allowing borrowers to layer in additional junior debt. For lenders such as Capital Southwest, these loans often carry floating interest rates tied to benchmark spreads, providing some protection against rate volatility.

Implications for Deal Flow

By leveraging the joint venture, Capital Southwest intends to allocate portions of larger credit facilities without concentrating exposure on its balance sheet. The strategy could help the firm participate in transactions that exceed its single-borrower limits, thereby diversifying risk across a broader borrower base. Management also expects the platform to accelerate origination volume, as sponsor relationships may view the combined capacity of both partners as a competitive advantage.

While the joint venture will operate independently for accounting purposes, Capital Southwest will continue to consolidate the economic benefits derived from its 50 percent ownership interest through earnings from equity method investments. Financial contributions from the venture are expected to appear in the company’s periodic results once initial loans are funded and interest income accrues.

Next Steps

The timeline for closing the credit facility and initiating investments was not provided. However, management signaled that sourcing efforts are already under way. Capital Southwest did not disclose target asset levels for the venture, but typical market practice suggests an initial equity commitment followed by incremental fundings as the loan portfolio scales.

Regulatory approvals are not anticipated to be a barrier, as the structure mirrors other joint ventures commonly utilized by business development companies to expand lending capacity. Capital Southwest will remain subject to the leverage limits and asset coverage ratios stipulated under the Investment Company Act of 1940, while the off-balance-sheet vehicle will manage its own leverage in accordance with negotiated credit facility covenants.

Crédito da imagem: Capital Southwest Investor Presentation