From Capital to Cash Flow
Designing Stronger Structures for Repayment and Recovery
In finance and banking, the word structure is used constantly, yet rarely defined precisely.
It is used to describe capital mix, collateral, covenants, guarantees, legal entities, waterfalls, and sometimes all of them at once. This leads to confusion, especially between business risk and structural strength.
This post sets out a clear, practical definition of structure from first principles, explains what structure can and cannot do, and introduces a six-block framework that bankers and clients can use consistently across corporate lending, project finance, leveraged buyouts, and bond investing.
Business Risk vs Structure Strength: A Necessary Separation
Before discussing structure, one distinction must be made clear.
Business risk
Business risk relates to:
- the stability of future cash flow
- the volatility of earnings
- the resilience of asset values
These risks determine whether a business can meet its obligations over time. They drive the probability of default.
Structure strength
Structure does not change business risk.
Structure determines:
- who absorbs losses when cash flow fails
- how much value is lost before recovery
- how quickly and reliably recovery occurs
In other words, structure shapes recovery and haircut, not the underlying economics of the business.
Higher business risk requires stronger structure if recovery is to be preserved.
This post focuses on structure strength, not on analysing business risk itself.
What “Structure Strength” Means in Practice
A strong structure typically results in:
- lower loss as a percentage of capital deployed
- faster access to cash or assets in stress
- less value leakage before enforcement
A weak structure often leads to:
- delayed intervention
- forced asset sales
- legal disputes over priority
- materially higher haircuts
Two financings exposed to the same borrower risk can produce very different outcomes because of structure alone.
De Jure Structure vs De Facto Structure
A critical distinction, often missed.
- De jure structure is what the legal documents say.
- De facto structure is what actually happens when cash becomes tight.
Examples of divergence:
- a senior lender ranked first in documents but unable to access cash
- collateral that exists legally but cannot be enforced quickly
- covenants that trigger only after value has already leaked
Senior practitioners focus less on labels and more on how cash, assets, and rights behave in real stress.
This is why structure must be examined in layers.
The Six Structure Blocks
We group structure into six practical blocks. Each answers a different question and affects recovery in a different way.
1. Loss Order
(Capital Loss Absorption Structure)
Key question: Who loses money first?
Loss Order determines how losses are absorbed when a business underperforms.
It is driven primarily by:
- equity versus debt
- senior versus subordinated claims
- hybrids that sit between the two
Worked Example 1: Same business, different loss order
Assumptions
- Asset value falls from 100 to 70
- No cash flow to service obligations
Structure A
Equity: 40 Senior debt: 60
Outcome:
- Equity absorbs 30 loss
- Senior debt recovers 100 percent
Structure B
- Equity: 10
- Subordinated debt: 30
- Senior debt: 60
Outcome:
- Equity and subordinated debt fully wiped
- Senior debt recovers 67 percent
Same asset outcome. Very different recovery.
Loss Order is the first and most powerful structural lever.
2. Legal Reach
(Legal and Entity Containment Structure)
Key question: Which assets are actually reachable?
Legal Reach depends on:
- which legal entity holds the assets
- which entity has borrowed
- guarantees between entities
- applicable insolvency regimes
Worked Example 2: Structural subordination
Group structure
- Holding company owns an operating subsidiary
- Assets sit in the subsidiary
Case A
- Lender lends to operating company
Outcome:
- Direct claim on operating assets
Case B
- Lender lends to holding company only
Outcome:
- Claim limited to equity in subsidiary
- Operating creditors rank ahead
Same group. Same assets. Different recovery perimeter.
3. Cash Control
(Cash Flow Control and De Facto Seniority)
Key question: Who controls the cash when pressure builds?
Cash Control determines practical seniority, regardless of legal ranking.
It includes:
- lockbox arrangements
- cash sweep mechanisms
- restricted accounts
- payment waterfalls
Worked Example 3: Senior on paper, junior in practice
Facts
- Borrower has senior secured loan
- Cash collected freely into operating accounts
Outcome
- Cash used for suppliers, taxes, dividends
- Lender waits for default to enforce
Contrast with:
- mandatory lockbox
- daily cash sweep to debt service account
Same loan. Same collateral. Very different outcomes.
Cash Control is often more decisive than legal priority.
4. Action Triggers
(Contractual Intervention Structure)
Key question: When can someone step in?
Action Triggers define when rights change as performance deteriorates.
They include:
- financial covenants
- information undertakings
- restrictions on distributions or new debt
- change-of-control and cross-default provisions
Worked Example 4: Early vs late intervention
Case A
- Covenant tested quarterly
- Breach triggers cash lock and review
Case B
- No maintenance covenants
- Action only at payment default
Outcome:
- Case A preserves value through early engagement Case B intervenes after cash is exhausted
- Case B intervenes after cash is exhausted
Triggers do not prevent failure. They preserve options.
5. Recovery Backing
(Asset and Credit Support Structure)
Key question: What backs recovery if cash flow fails?
Recovery Backing includes:
- physical collateral such as property or equipment
- financial support such as guarantees or letters of credit
Important distinction:
- physical assets rely on liquidation value
- guarantees rely on third-party cash flow and balance sheet
Worked Example 5: Asset-backed vs guarantee-backed
Loan size: 50
Case A
- Secured by property valued at 60
- Illiquid market, long enforcement
Case B
- Unsecured loan with parent guarantee
- Parent has strong cash flow
Outcome:
- Case A recovers slowly and with discount
- Case B recovers faster, often at par
Both are “secured” in different ways. Their risk drivers differ.
6. Stress Buffer
(Liquidity and Execution Support Structure)
Key question: Can value survive stress without forced loss?
Stress Buffers reduce the need to sell assets or enforce rights at the worst time.
They include:
- liquidity reserves
- debt service reserve accounts
- committed standby facilities
- enforcement mechanics that reduce delay
Worked Example 6: Forced sale vs buffered survival
Scenario
- Temporary revenue shock
- Asset values intact but illiquid
Without buffer
- Missed payment
- Immediate enforcement
- Fire-sale haircut
With buffer
- Reserves cover obligations
- Time to stabilise or refinance
Liquidity often reduces loss more effectively than collateral.
How Structure Responds to Business Risk Over Time
Business risk can change quickly.
Structure changes slowly because:
- documents must be renegotiated
- multiple parties must agree
- legal and regulatory processes take time
This creates a structural lag.
The most effective structure is designed before risk rises, not after.
Once bargaining power is lost, improving structure becomes difficult and expensive.
What Structure Can and Cannot Do
Structure cannot:
- fix weak demand
- stabilise volatile business models
- prevent default indefinitely
Structure can:
- reduce loss severity
- improve recovery certainty
- shift loss to parties better able to absorb it
Understanding this boundary prevents false confidence.
Applying the Framework Across Scenarios
The same six blocks apply across contexts, but emphasis differs.
- Corporate lending: balance between Cash Control and Recovery Backing
- Project finance: heavy focus on Cash Control and Stress Buffers
- Leveraged buyouts: Loss Order and Action Triggers dominate
- Bond investing: Legal Reach and Recovery Backing are critical
Each scenario is explored in dedicated posts.
Practical Tools for Bankers and Clients
This framework is supported by:
- a Structure Strength checklist
- scenario-specific worksheets
- one-page cheat sheets for quick reference
These tools are designed to support judgement, not replace it.
Closing Thought
Business risk determines whether problems arise.
Structure determines what remains when they do.
When optimism fades, structure is what decides outcomes.
Next suggested reading
- Cash Control explained with full numerical walkthroughs
- Structure Strength checklist for bankers
- How structure differs in project finance and LBOs
