If you have ever stood beneath a glass skyscraper and felt a small pang of vertigo, you already understand the first emotion most newcomers feel when they look at a modern acquisition’s capital structure. It is tall, reflective, and complicated. Bank term loans, revolvers, first-lien notes, second-lien notes, mezzanine, preferred equity, PIK toggles, seller paper—the list reads like the credits at the end of a Marvel movie. Collectively, those layers form the debt stack.
For the past decade, cheap money has pushed buyers to build ever-taller stacks, rebranding plain-vanilla “borrowing” into something that sounds almost sophisticated. The danger, of course, is that while names can change, math does not. In M&A, a loan by any other name still needs to be serviced.
Below is a field guide to understanding why the stack keeps getting higher, how risk is disguised inside it, and what deal teams can do to make sure their next acquisition does not topple under its own weight.
Why the Stack Exists in the First Place
Leverage has always been the not-so-secret sauce of private equity. Use someone else’s money, generate a higher internal rate of return (IRR), and recycle capital faster. Straightforward. Yet two structural changes have encouraged a bigger appetite for layered debt:
- Ultracheap base rates. When LIBOR (and now SOFR) hovers near the floor, saying no to incremental borrowing feels like leaving free chips on the table.
- Yield hunger among lenders. CLOs, direct-lending funds, and insurance companies need paper. To win mandates, they accept junior positions, looser covenants, or both.
Together, those forces let borrowers swap out equity for debt, paying 8–12 percent blended cost of capital instead of giving up upside to a co-sponsor. On the slide deck, the deal suddenly looks brilliant.
Anatomy of the Modern Debt Stack
Picture a five-layer wedding cake:
- Revolving Credit Facility: Like an overdraft on steroids. Usually secured by working-capital assets and swinging daily with cash needs.
- First-Lien Term Loan: The traditional senior loan. Lowest coupon, tightest covenants, longest queue position if something goes wrong.
- Second-Lien Notes or Unitranche “Tranche B”: Higher rate, fewer covenants, but still labeled “secured,” which soothes rating agencies.
- Subordinated/Mezzanine: Often PIK (payment-in-kind) interest, meaning the borrower can roll interest into additional principal. Great for cash flow today—cruel in Year 4.
- Preferred Equity or Vendor Paper: Technically equity, practically debt. Comes with fixed dividends, redemption dates, and sometimes puts back to the company.
Each layer claims a slightly different risk profile, which gets reflected in coupon and documentation—yet the operating cash flow that services all five layers is the same single stream.
Rebranding Risk: From “Debt” to “Flexibility”
Marketing, not finance, is what makes a stack feel palatable. Consider three bits of linguistic alchemy:
- Unitranche: Sounds unified and simple. In practice it fuses senior and junior risk into one facility with hidden agreements that slice recoveries behind the curtain.
- Covenant-Lite: When covenants disappeared from bank loans after 2013, sponsors reframed the absence of hurdles as “flexibility for management.” Lenders, lured by yield, nodded along.
- PIK Toggle: Instead of paying cash interest, the borrower can toggle to in-kind payments. Translation: you pay later, with compounding. Issuers call it a liquidity tool; critics call it kicking a steel can down the road.
Language matters because it shapes perception. Stakeholders see “flexibility” in the term sheet and mentally discount risk, even though leverage multiples may be at all-time highs. The stack becomes an optical illusion—a skyscraper made of mirrored panels that hides its own height.
When Stacks Collapse: A Quick Postmortem
Look at recent restructurings and a pattern emerges:
- Payless ShoeSource (2017): 6.3× total leverage at close. Second-lien lenders forced to accept equity after the first-lien seized collateral.
- Neiman Marcus (2020): PIK toggle notes ballooned, COVID killed sales, litigation erupted over asset transfers placed beyond creditors’ reach.
- Cineworld (2022): Covenant-lite first-lien loans delayed lender intervention until liquidity was exhausted; junior tranches were wiped out.
In each case, headline leverage appeared manageable on Day 1. Trouble hit when a slim operating cushion met an external shock—declining foot traffic, a pandemic, streaming wars. The debt itself did not cause the crisis; it removed the margin of error that might have absorbed it.
Warning Signs Deal Teams Should Not Ignore
Not all large stacks are doomed, but a few red flags warrant a hard pause:
- PIK interest greater than 20 percent of EBITDA at any point in the model. Compounding will outpace growth the minute results flatten.
- Covenant-lite combined with minimal maintenance capex covenants. Absent triggers, management can operate in denial too long.
- Asset transfers that move IP or real estate to unrestricted subsidiaries. If the sponsor needs complexity to get the deal financed, assume the exit will be equally complex—just not in your favor.
- Dividend recaps inside 24 months of close. If owners cash out early, they implicitly cap their own downside but leave lenders fully exposed.
Practical Ways to De-Risk Without Killing the Deal
Nobody wins by banning leverage altogether. The goal is calibrated risk, not abstinence. Try these pragmatic adjustments:
- Earn-outs Over Excess Leverage: If the pro-forma plan assumes hockey-stick growth, tie a portion of the purchase price to that performance rather than loading it into debt today.
- Springing Covenants: A material draw on the revolver can “spring” a financial covenant earlier, forcing dialogue while there is still runway.
- Equity Cushions From Co-Investors: Family offices or LP co-invest can provide passive equity dollars, preserving sponsor IRR without pushing leverage past 6×.
- Pre-wired Intercreditor Agreements: Spell out waterfall recoveries before closing, so a restructuring battle does not consume all residual value in legal fees.
What Rising Rates Mean for the Stack Era
For years, the central-bank safety net masked leverage sins. That story flipped in 2022. Every 100-basis-point rise in SOFR adds roughly half a turn of leverage cost at 6× EBITDA. Sponsors now face a choice: accept lower returns, or hand back deals. Expect shorter tenors, bigger equity checks, and the return of old-fashioned covenants under fancy new headers like “performance milestones.”
Conclusion
Debt itself is not the villain of the M&A world; mispriced risk is. The capital structure can be a precision-engineered tower or a Las Vegas replica—glittering until the first strong wind. As a buyer, banker, or advisor, your job is to walk around the tower, tap on the columns, and look for cracks behind the marble veneer of rebranded risk. Ask simple questions: Does cash flow cover fixed charges in a stress case? Are incentives aligned if growth stalls?
Will lenders still be around for amendment talks two years out? Strip away the marketing phrases, and what remains is a basic engineering problem: weight versus load-bearing capacity. If your analysis says the stack can carry the weight, sign the deal and enjoy the view from the top floor. If not, remember that the best transaction you ever do might be the one you gracefully walk away from—before the rebranding exercise turns back into plain old, unvarnished risk.
